While the cash-out refinance option has grown slightly in popularity among consumers with strong equity, it has hardly returned to the loan of choice during the halcyon days before the recession of 2007-2009. Under cash-out refinancing, the owner pays off the existing mortgage and replaces it with a new mortgage that includes the amount of cash taken out against the equity. Paying off higher interest and establishing a lower interest rate is one good reason to pursue a cash-out refinance, as is the need to pay off huge credit card debt, medical bills or even college tuition. And while a cash-out today still remains an option, qualifying is tougher than five years ago and, depending on individual circumstances, other refinancing opportunities may ultimately prove to be wiser choices.
The Los Angeles Times reports that during the 2004-2007 housing boom, nine out of 10 homeowners that refinanced took cash as part of their new loan packages. After the collapse in 2009, the FHA responded to increased risk by limiting cash-out refinance ceilings to 85 percent of the appraised value plus closing costs. Now, with home values slowly on the rise again, more consumers are looking into what types of financing increased equity can bring. LendingTree reports that cash-out bid requests rose 40 percent in the first quarter of 2015 over the same quarter the year before.
Let's examine the pro's and con's of a cash-out refinancing:
Pros of Cash-out Refinancing
- Homeowner receives cash but retains ownership of the property.
- Unrestricted use of the money.
- No taxes on the cash. Since the borrower agrees to add the cash amount to the mortgage, there is no earned income or gift involved.
- Federal tax deductions on cash-out interest payments – if the cash is used to upgrade or improve the home.
- Interest rates are typically lower than those offered on home equity loans (HEL) or home equity lines of credit (HELOC).
Cons of Cash-out Refinancing
- You have cash for now. But if you're walloped with crippling medical bills or a financial disaster, your house is on the line.
- You pay closing costs: Closing costs on a cash-out refinance can run into the thousands of dollars. Borrowers should have a handle on the amount of equity they have against the entire price of a cash-out refinance, along with their ability to pay a sustained amount over the term.
- Restrictions: Depending on the lender, restrictions can include mandatory ownership of the home for one year prior to refinancing, meet minimum credit scores (typically higher than those required for regular home refinancing packages), and the loan-to-value ratio not exceeding 85 percent of the appraised value.
- Mortgage insurance: Homeowners that secure a cash-out refinance may have to pay private mortgage insurance (PMI) if their LTV exceeds 80 percent. The private lender is not required to remove the PMI requirement until the principal balance drops below 78 percent of the total value of the home. Consumers may want to think twice before getting hit with mortgage insurance.
Before taking on a cash-out refinance, be sure to study the other options available for consumers who are concerned about the requirements and provisions of a cash-out refinance. At LendingTree, these include: