Is a Cash-out Refinancing Right for You?

In a cash-out refinancing, you take out a new mortgage for an amount that's larger than your current principal balance. You can then use the extra money as you wish. Just make sure that you compare the costs of this type of financing with the costs of a home equity loan before proceeding.

We've all heard the expression, "You need to take out a second mortgage to be able to afford a new ________." You can fill in the blank with the words car, kitchen, home addition, etc. Maybe the first college tuition bill has just arrived, or a recent illness has resulted in a stack of medical bills that aren't covered by insurance. A second mortgage is one way to handle raising the extra cash-but a cash-out refinancing may be a better answer.

Best uses

Let's suppose that your daughter is going to a private college and, even with scholarships and grants, your pockets aren't deep enough to cover the next four years. Compare rates and terms for student loans with those for a cash-out refinancing to find extra money. One advantage of a mortgage refinancing is that the interest is generally tax deductible. Therefore, the after-tax rate may be very competitive.

Here's another solid use for a cash-out refinancing: You bought a two bedroom, one bathroom starter home with the intent of moving to a larger home once you had children. Two kids later, you need more space. With the current pressure on sellers in the real estate market, it isn't a great time to put your home up for sale. One option would be to take the cash from the refinancing and add on a bedroom. You can benefit from it today, and recoup the money that you invest after you sell.

Not the best alternative

If your credit card balances are overwhelming and you're looking to consolidate and lower your interest rate, a cash-out refinancing may not be the answer. If you take out a 30-year mortgage, you'll be paying off those cards for the next 30 years. A home equity loan may be a better option here.

One benefit of a home equity loan is that there are relatively low closing costs. If your credit is good, you may be able to find one with no closing costs at all. However, with a cash-out refinancing, you'll have the same closing costs as you do with any traditional mortgage-and these can be steep. The benefit is that you can generally lock in a lower interest rate than with a home equity loan, so it may all even out in the end.

Even with the downturn in the real estate market, you may have built up equity in your home. When life throws you curveballs in the way of unexpected expenses, a cash-out refinancing may be a good way to step up to the plate and swing with confidence.