If you have some equity in your home and you need cash for something, you have the option to refinance your mortgage in a manner that puts cash directly in your pocket. This type of refinance is called cash back or cash out refinance.
Cash back refinance has gained a lot of popularity and an increasing number of refinances these days are cash out refinances.
These days, houses are treated just like other assets by the homeowners as they can readily transform their equity in the house into credit and cash. Cash back refinancing allows homeowners to tap in to their equity in the house by replacing the existing mortgage with a larger mortgage and pocketing the difference.
Suppose the value of a house is $500,000 and it has an existing mortgage of $300,000 which means the homeowner has home equity worth $200,000. Now, the homeowner has the option to tap into this home equity worth $200,000.
One of the ways to tap into this home equity is to take a mortgage of $400,000 and pay off the existing mortgage of $300,000. The remaining $100,000 will go into the pocket of the homeowner.
In simple terms, cash out refinance completely replaces the current mortgage and the new mortgage comes with new terms and conditions and different interest rate. You can use the funds generated from cash back refinance at your discretion as the lender won’t ask why you want the money.
Homeowners usually use this money to invest in something in the hope of generating a return in the future such as necessary household purchases, education related expenses, home remodels, debt consolidation and other such things.
One of the biggest advantages of cash out refinancing is that it allows homeowners to access the money in an illiquid asset. The money raised through cash out refinancing can be used to pay off big bills such as medical expenses, college tuition, home improvements as well as new business funding among other things. Usually, it is offered at a more attractive interest rate as compared to unsecured personal loans, credit cards and student loans.
It can also be smartly used for improving the debt profile of the homeowner as the money raised through cash refinance can be used to pay off high interest rate credit card debt or other such debts.
Many homeowners choose cash out refinancing for their home improvement projects as it allows them to get a steady interest rate.
It has been observed that even if the homeowner gets a lower interest rate for the new mortgage as compared to the existing mortgage, the refinance rate tends to be a bit higher than the regular refinance rates.
The process also tends to be a bit cumbersome as compared to the first mortgage. One needs to submit a lot of documents depending on their situation. Also, the homeowner may be required to pay closing costs at the end of the refinance.
As far as the eligibility for cash out refinance concerned, it depends on your credit score and loan to value ratio among other things.
Overall, a cash back refinance is a smart way to tap into the homeowner’s equity in an illiquid asset.