A Cash-Out Refinance is the best way to refinance your mortgage to a lower rate and take money out and put it in your pocket. Essentially, you are taking out a new mortgage to replace your current one, Your new mortgage balance will be higher than the previous one by the amount that you’re taking out.
At the end of the transaction, you walk away with a check.
You can use this money for anything, but the tax ramifications for the different uses are worth checking out, we’ll get into that below.
A Cash-Out Refinance is often used for paying off higher-interest loans like credit cards, making home improvements or repairs to your home, starting a new business, paying medical costs or education costs.
Where Does the Money Come From
A Cash-Out Refinance uses the equity that you have built in your home through home value rising and your monthly payments to fund the money you take out.
You’ll need to have a certain amount of equity built up in your home before you can take cash out.
If your home is worth $250,000 and you currently have $150,000 left on your mortgage, that gives you $100,000 in home equity, which translates to 40 percent of the home’s value.
You want to keep at least 20% of your home equity to avoid paying PMI (Private Mortgage Insurance) so that will leave you with $50,000 you can borrow.
To get that, you would take out a new mortgage for $200,000 (the $150,000 that you currently owe, plus $50,000) and get a $50,000 check at your closing. You’ll also be responsible for closing costs, usually anywhere from 3-6% of the total mortgage, but those are rolled into the loan, so you’re not writing a check that day.
Advantages of a cash-out refinance
Mortgage rates will usually be lower than the interest rates you would pay borrowing money on a credit card or typical bank loan, so it’s a smart way to borrow money. If you’re doing it to pay off credit cards, you’re generally exchanging high-interest debt for low, which is a good swap to make.
You’re also allowed to pay this loan back over a much longer period, anywhere up to 30 years, so the payments will be much lower if you have a large amount of credit card debt and want to get rid of it.
Right now, interest rates are near the lowest in history, so it’s a great time to refinance to a lower rate, regardless of whether you want cash out.
Since mortgage interest is usually tax-deductible, you can also take that deduction up to certain limits, if you are itemizing deductions.
You can deduct mortgage interest paid on the loan principle up to $1 million for a couple or $500,000 for a single filer if you use the loan funds to buy, improve, or build a home.
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