Is cash-out refinancing still a good idea right now?
- With a payout refinance, you can borrow your home equity and use the money for other financial goals.
- The average home price in the US has increased from $329,000 to $408,100 over the course of the pandemic, giving homeowners plenty of equity to tap into.
- Now could be a good time for a cash-out refinance as house prices are rising while mortgage rates are still relatively low.
- Read more from Personal Finance Insider.
Mortgage rates are rising and as a result Fewer Americans are interested in refinancing.
However, thanks to the breakneck surge in home prices that has shaped the pandemic housing market, homeowners are also sitting on a lot of equity right now.
In the first quarter of 2020, the average home price in the US was $329,000. According to Q1 2022, that number has increased to $408,100 Data from the Census Bureau and Department of Housing and Urban Development.
Because homeowners have appreciated so much in value over the past few years, many are in a good place to leverage their equity with a payout refinance — even as interest rates continue to rise.
How does a cash out refinance work?
As with an interest rate and term refinance, a payout refinance replaces your current mortgage with a new one. With a payout refinance, however, you borrow more than what you currently owe on your mortgage and pocket the difference. In most cases, you can mortgage up to 80% of the value of your home. Here’s an example of how this might work:
Your house is worth $300,000 and you owe $150,000 on your mortgage. You choose a payout refinance for the full amount you can borrow, which is $240,000 (or 80% of $300,000). Once you pay off your current mortgage, you are left with $90,000 (240,000 – 150,000 = 90,000) minus closing costs. You can use these leftover funds as you wish.
Mortgage rates are rising, but they’re still relatively low
Typically, it only makes sense to refinance your mortgage if you can get a lower interest rate than what you are currently paying. Interest rates are now higher than the all-time lows of the past two years. But they’re still down from their 2018 peak when they surpassed nearly 5%, based on data from Freddie Mac.
Also, even when interest rates are rising, a cash-out refinance is often cheaper than other options, says Melissa Cohn, regional vice president of William Ravei’s mortgage.
“Mortgage rates are significantly lower than credit card debt or other types of loans,” says Cohn.
For example, while national mortgage rates are still below 5%, many people pay well over 10% interest on credit card debt. And the lower your credit score, the higher your credit card rates can be.
Homeowners have gained a lot of equity during the pandemic
A big reason why payout refinancing can still be beneficial for homeowners is that there is plenty of equity available to this group after two years of rapidly increasing home values.
Since market conditions have gifted homeowners with essentially free money, it may make sense to tap some of that wealth and use it to improve your financial situation, either by reinvesting it in your home or consolidating high-interest debt.
Sonu Mittal, head of mortgage at Citizens Bank, says he often sees people using cash-out refinances for things like home improvement, debt consolidation, or to cover big purchases.
“People can use the money for whatever financial needs they have,” Mittal says. There are no rules as to how you can spend the money.
Although home renovations usually not fully pay for themselvesthe right ones can help to increase the value of your home a bit and to increase your enjoyment of your own home.
Withdrawal refinancing can be cheaper than other options
Cash-out refinancing allows you to borrow money at a relatively low interest rate and pay it back over a long period of time.
Alternatives to cash-out refinancing include home equity loans or lines of credit, personal loans, or credit cards. The best option for your situation depends on how much you need to borrow, how quickly you can repay the money, and how much you will be paying in interest and fees.
“If you plan to use the proceeds from your payout refinance for a home renovation, debt consolidation, or other life-changing event in the near future and don’t expect to pay it off or settle materially in two to three years, fixed-rate mortgages give you peace of mind and reduce the impact on your monthly cash flow because you can amortize it over 30 years,” says Mittal.
Bottom line: If you can get a cash-out refinance at a lower interest rate than your other loan options, and you have enough equity in your home, it could be a smart move.