Why Should I Avoid a Cash-Out Refinance?

College tuition With the rising costs of higher education, the money from cash-out refinancing can allow you to pay you or your relative’s college tuition without having to enter into the higher-interest debt of a private student loan or federal parent PLUS loan.

These closing costs can vary between 2-5% of the loan amount, meaning a $150,00 cash-out refi requires a $7,500 out-of-pocket expense

Home improvements and repairs One of the most common reasons for securing a cash-out refinance is for home improvements, upgrades, and repairs, which can help you twofold.

First, when done right, updating key areas of your home, such as the bathroom or kitchen, will often increase its value, thereby increasing your equity. In this situation, the refi almost pays for itself. Second, if you use the cash to improve your home you may be able to deduct additional interest payments from your taxes.

“Homeowners with sufficient equity can take advantage of the current historically low interest rates to secure tax-free cash for projects that can increase the value of their home,” says Bill Banfield, executive vice president of capital markets for Rocket Mortgage.

Possible high, up-front closing costs Some lenders will fold any closing costs or fees into your monthly mortgage payments or you could pay the closing costs upfront.

High break-even point As mentioned, it’s important to calculate the break-even point in order to determine whether refinancing is right for you. High-break even points don’t provide the financial relief needed to justify cash-out refinancing, particularly if you’re Mount Vernon online payday loans thinking of moving within that time frame.

Foreclosure risk No matter the purpose for which you decide to refinance, you’re going to be putting your home at risk if you ever default on your payment.

This is especially true if you’re using your cash-out refi to pay off credit card debt, as you’re basically exchanging unsecured debt for secured debt. Missing payments on a credit card can lead to penalties, credit score damage, and collections. However, defaulting on your mortgage can lead to foreclosure and the loss of your home.

A cash-out refinance also lowers your home equity, thereby increasing your risk of owing more than the home is worth if its value ever decreases.

Using the money for non-essentials Even though a cash-out refinance provides tax-free cash, it’s not usually recommended for large purchases or expenses such as a new car or vacations for the same reason mentioned above: risking foreclosure to pay for a luxury or non-essential item is not a wise financial strategy.

Additionally, going through a cash-out refinance is basically the same as the original home buying process, with an appraisal and an underwriting period that can take a few months to complete. “If homeowners need money immediately, a cash-out refinance may not be the right solution,” adds Banfield.

Is It a Good Idea to Take a Cash-Out Refinance for Investing?

With some investment opportunities appearing to afford you a high rate of return, you might be tempted to consider a cash-out refinance to get extra funds for investing.

This, however, must be pursued with extreme caution. The volatility of investment iliarity of how these markets work, can lead to personal financial turmoil.

“There are no restrictions to how a borrower can use the money. However, that also means accepting the full responsibility of spending the money in an appropriate manner that won’t put your home at risk,” says Banfield.

Buying additional real estate or investment properties could also be a consideration, especially if they generate rental income. But ultimately only a homeowner knows their tolerance of risk, and seeking out professional advice before determining how to proceed is essential. Risking your home and equity by trying to capture lightning in a bottle might not be a sound financial strategy