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When refinancing your mortgage, you may have the opportunity to take "cash out" of your home equity. To receive a one-time cash payment during the refinancing process, you'll need get a loan for more than you owe on your principal mortgage balance. Keep in mind that with a cash-out refinancing, you are also increasing your overall level of mortgage debt.
Common uses for cash-out refinancing
Cash-out refinancing is often used to consolidate high-interest, nondeductible debt. Because your mortgage interest rate is likely to be lower than credit card rates or other types of bank loans, consolidating debt has the potential to reduce your overall monthly1 debt payments. In addition, your mortgage interest may be taxdeductible, while your credit card interest is not. Another popular use for a cash-out refinancing is to finance a nonrecurring expense — such as purchasing a car, paying for a wedding or financing an education — that might otherwise require you to borrow funds at a higher, nondeductible interest rate.
Consider all of your options
If your home is an important part of your total net worth, consider all of your options carefully before taking cash out of its equity. If you are planning to consolidate debt, you must be committed to reducing your spending in other areas. Consolidating debt and then taking on new consumer debt will simply increase your overall liabilities, while potentially giving you a false sense of financial security. In addition, if you are considering using cash-out refinancing to pay educational expenses, keep in mind that many state and federal educational loan programs also offer tax-deductible interest, so you should carefully consider which option is most advantageous for you.
1. The amount you save on loan consolidation may vary by loan. Since a home loan may have a longer term than some of the bills you may be consolidating, you may not realize savings over the entire term of your new loan. In addition, your loan may require you to incur premiums for hazard and, if applicable, flood insurance and mortgage insurance which would affect your monthly payment reduction. Federally Guaranteed Student Loans should not be consolidated because you will lose important federal benefits.
