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Your credit-card debit is growing out of control. Maybe your home's kitchen hasn't been updated since the 1970s. Or maybe you haven't saved a penny for that child who's set to enroll at Harvard next year.

A cash-out refinance could be the answer.

Or it might not be. It all depends on your financial situation and the fees that a lender will charge you for that cash-out refinance.

As with most mortgage matters, you need to take a close look at your own financial sitution to determine if a cash-out refinance is a smart move for you.

What a cash-out refinance is

Homeowners can rely on cash-out refinances to secure a large sum of money for everything from home improvements to paying off high-interest credit-card debt. In a cash-out refinance, you end up with a larger mortgage loan than the one you are closing out. You then receive the difference between the two loans in cash.

Here's an example: You might owe $200,000 on your existing mortgage. When you refinance, you get a new loan worth $230,000, hopefully at a lower interest rate. You then get the extra $30,000 in cash. You can use this money for whatever you'd like.

There is a downside here. You will now be paying back $230,000 in mortgage debt instead of $200,000. Because you are adding to your debt load, it's important to make sure that you are using the cash you receive for a worthy cause.

The costs

It's important, too, to remember that a cash-out refinance isn't free. Yes, you'll be getting that large sum of cash when it's over. But your lender will be charging you origination fees that could be in the thousands-of-dollars range. Often, you'll roll these fees into your new monthly payment. Or you could just pay them off all at once with the cash you receive.

Your new interest rate is important, too. The lower your new rate, the lower your monthly mortgage payments. You want to make sure that your new loan comes with an interest rate that is lower than the one attached to the loan you are refinancing. If your rate drops by a large enough amount, your new monthly payment might be lower, even though your new loan will be a larger one.

The key is to not let the thought of that lump sum of cash you'll receive entice you into a deal in which the cost of your new loan is too high. Ideally, even though you're refinancing for a larger loan amount, you want your monthly payments to fall because your new interest rate is so low.

"If refinancing costs you $800 and you're saving $200 a month by lowering your rate, your break-even time is four months. That's a good deal," said Jason van den Brand, chief executive officer of online refinance company Lenda. "But if the break-even time is 400 months, that's longer than the term of the mortgage itself."

Say you still owe $200,000 on a 30-year fixed-rate loan with an interest rate of 6 percent. You'll be paying about $1,199 a month, not including property taxes and homeowners insurance. If you refinance that loan to a $230,000 30-year fixed-rate mortgage with an interest rate of 3.5 percent, your monthly payment -- again, not including taxes or insurance -- will drop to about $1,032.

That's a monthly savings of about $167, or about $2,004 a year. If your lender charged you $4,000 in closing costs, it would take you a little less than two years of monthly savings to recover those costs. That's not a bad deal.

Use the money wisely

Because you are adding to your debt load, it's important to use the dollars from a cash-out refinance wisely, van den Brand said. Maybe you have $25,000 in credit-card debt at an interest rate of 19 percent. It makes financial sense to take out a cash-out refinance with a far lower interest rate of 3.5 percent to pay off that debt.

It can also be a wise decision to use the money from a cash-out refinance to pay for improvements to your home, van den Brand said. If you use the money to cover the costs of a new kitchen or remodeled master bathroom, you can actually increase the value of your home, something that will pay off when it's time to sell.

What doesn't make good financial sense? Don't use a cash-out refinance to fund a trip to Las Vegas or to buy a new car, van den Brand said. Those are not good reasons to take on added debt, he said.

"The important question for the borrower is: how do you plan to use the cash? If it's a home renovation or college tuition or even to pay off high interest credit card debt, that may be OK," said Laura Williamson, senior vice president of client services at Digital Risk, a loan-processing company based in Maitland, Florida. "Keep in mind, you are increasing the size of your mortgage loan. If you can't repay this loan you could face foreclosure."

An alternative

A cash-out refinance isn't the only way to use your home for a lump sum of cash. You can also take out a home equity loan. This is a second loan that you pay back each month in addition to your primary mortgage. How much you can borrow depends on the equity in your home.

If you owe $200,000 on your 30-year mortgage and your home is worth $250,000, you have $50,000 worth of equity. A lender might then approve you for a home equity loan of $35,000. As with a cash-out refinance, you'd receive that money as a lump sum to spend on whatever you want.

You pay that money back every month, just as you do with your primary mortgage. The biggest benefit of a home equity loan is that lenders charge lower fees for them. The biggest downside? They usually come with higher interest rates than do cash-out refinances.

Williamson said that homeowners need to understand that if they don't make their payments on a cash-out refinance, they could lose their home through a foreclosure. Homeowners can consider other options if they need a large sum of cash, she said. They could borrow from their 401(k). They'll repay themselves on that loan, although they will face a tax hit. A personal loan, too, might be an option for homeowners who can repay quickly what they've borrowed.

"That way, you don't risk your home in the transaction," Williamson said.

Published on November 10, 2015