Cash borrowed from your home’s equity can be used to pay off high-interest credit card debt. Debt consolidation* can simplify your finances and reduce how much you pay in credit card interest. But you should only tap your equity for debt consolidation if you’re committed to using credit cards responsibly moving forward. You don’t want to fall into a circumstance where you pay off your credit cards with your home equity but then max out these cards again, essentially doubling your debt.
A cash-out refinance can help provide extra cash when you need it, but it’s important to remember that this isn’t free money. While cash-out refinances have a slew of benefits, there are also some drawbacks and risks.
What are the pros of cash-out refinances?
Lower interest rate. Refinancing for a lower interest rate is one of the main reasons to do any refinance – cash-out or regular. A lower interest rate can save you thousands of dollars in interest over the life of the loan.
Debt consolidation*. Many people use the funds received from a cash-out refinance to pay off debt. This can be a good move if you have high-interest debt, like credit card debt.
Home renovations. It makes sense to use your home equity to make improvements to your home. Smart improvements can add value to your home and in turn increase your equity.
Increased credit score. By paying off your credit cards in full through a cash-out refinance, your credit score could increase by reducing your credit utilization ratio.
What are the cons of cash-out refinances?
Risk of foreclosure. If you fail to repay the loan, your home is on the line and you could end up losing it. Don’t increase your risk by taking out more cash than you need.
Private mortgage insurance (PMI). If you withdraw more than 80% of your home’s equity, you’ll have to pay for PMI – even if you’ve already canceled it.
Increased interest rate. When you do a cash-out refinance, your new mortgage will have different terms than your original loan. This means you could end up with a higher interest rate.
Enables bad financial habits. Using a cash-out refinance to pay off credit cards or book lavish vacations can give you a false sense of security to live beyond your means. If you’re struggling with debt or to control your spending habits, consider reaching out to a non-profit credit counseling agency.
Alternatives to a cash-out refinance
While a cash-out refinance can be a great option for some homeowners, there are other ways to get the funds you need. Do your research to determine which solution is the best fit for your financial situation.
Personal loans. You can apply for a personal loan at a bank, credit union, or with an online lender. Personal loans allow you to borrow money without adding to your home-related debt.
Second mortgages. more helpful hints Add a home equity loan or line of credit (HELOC) to borrow against your home. This approach allows you to keep the terms of your original mortgage.
Reverse mortgages. Homeowners over the age of 62 can take advantage of a reverse mortgage. Reverse mortgages allow homeowners to convert their home equity into cash in lump-sum or monthly payments.
The bottom line
A cash-out refinance can make sense if you can lower your interest rate, and you plan to put the funds to good use. But, the decision to do a cash-out refinance shouldn’t be taken lightly. Remember, your house is on the line as collateral should you default on the payments. Make sure to crunch the numbers to determine whether a cash-out refinance is the right move for you. Our mortgage calculator can help you determine how a new rate and terms might impact your payments.