5 Min Read | November 17, 2022
Cash-Out Refinancing: When Your Home Is Your Piggybank
Learn the risks and rewards of doing a cash-out refinancing of your mortgage to help tackle some of your biggest personal finance goals and challenges.
At-A-Glance
Cash-out refinancing is on the rise, with mortgage interest rates recently at historic lows.
Tapping into the money invested in your home could help in hard times or in funding major personal goals.
But you may not want to risk your home in the process; it’s much more than a piggy bank.
Homeownership is like America’s piggy bank. Collectively, millions of Americans have trillions of dollars invested in their homes. And each month, with each mortgage payment, homeowners invest a bit more. But should the need arise, they can also break into the piggy bank – tapping the home equity they’ve built up over time through a cash-out refinancing of their mortgage.
Cash-out refinancing works by replacing your mortgage with a new one whose amount is higher than what you currently owe. That way, you get cash to use for other purposes. A second type of refinancing, known as rate-and-term refinancing, is used by homeowners who are looking for better mortgage terms but aren’t looking to pocket extra cash. For more, read “When and How to Refinance a Home Loan.”
Most mortgage refinancing is cash-out refinancing. This primer lays out why some people do cash-out refinancing, why others don’t, and what you should ask yourself before refinancing.
Why People Do Cash-Out Refinancing
For many people, cash-out refinancing can be an enticing option for several reasons, such as:
- Economic downturn: Some homeowners turn to cash-out refinancing to shore up their finances during economic downturns.
- Major personal finance goals: People also tend to tap their home equity to make home renovations, help send their kids to college, consolidate debt, or fund other major goals.
- Low interest rates: As interest rates hovered at or near historic lows for the past two years, cash-out refinancing became a more attractive way to raise cash, in and of itself. It remains that way for now, even though rates have recently begun to slowly climb. And some homeowners can also improve on the terms of their current mortgage – even while withdrawing cash. Most people associate this goal of lowering interest rates with rate-and-term refinancing, but the result can also be a win-win if you’re doing cash-out refinancing.
- Lower rates than other types of loans: Cash-out refinancing may offer lower interest rates than many other forms of credit. But remember: Rates can vary due to interest rate volatility, as well as location, lender, borrower, length of loan, and other factors. But the comparisons are usually similar, with cash-out refinancing offering the lowest rates.
Why People Don’t Do Cash-Out Refinancing
Of course, a home is more than a piggy bank. Financial advisers like to remind everyone that refinancing your mortgage is a big step that should be taken carefully.
- Risk: Increasing the amount you owe on your home could increase your risk of defaulting on that loan and possibly losing the roof over your head. For example, following a surge in cash-out refinancing before the Great Recession in the 2000s, millions of homes ended up in foreclosure.
- Fees and terms: The interest rate is not the only cost of the loan. A long list of closing costs could add 3-6% to the total loan. And even if the monthly interest rate is lower than what you’re now paying, you could end up with a higher total cost if you take on, say, a new 30-year loan that extends your debt further into the future.
- Hassles: Mortgage applications always involve red tape. And when cash-out refinancing is in high demand it can get worse: Loan processing times lengthen and breakdowns can occur at any step, such as with appraisals or title searches.
- Just not worth it: If bankers increase your interest rate because your credit score or other aspects of your financial profile don’t meet their standards, the loan simply may not be worth the hassle and the cost.
3 Questions to Ask When Considering Cash-Out Refinancing
Before you break open the cash-out refinancing piggy bank, ask yourself these top-level questions (and you can test your final answer on one of the many online refinancing calculators):
- How’s the market doing? In the early 2020s, the real estate and mortgage industries are facing pricing uncertainty and other challenges. For mortgage shoppers, this has translated into volatile interest rates, changing home values, hassles in processing loans, and tightened lending requirements, such as higher credit scores.
- How are you doing? Consider your current and future ability to make mortgage payments. Is your job and/or income in jeopardy? Or are you on the fast track to job and/or income advancement?
- What’s the true price you’ll pay? While rough estimates for interest rates are cited above, precision is essential when actually shopping for a loan. Differences of only a fraction of a percent can ultimately make the total cost of your loan thousands of dollars more or less expensive over time. Extra costs like fees need to be calculated, and hidden costs such as risk need to be weighed in the balance.
The Takeaway
Maybe your home could be your piggy bank, if you do cash-out refinancing when you need money. But if that piggy bank could talk, it would ask some pretty tough questions before giving up the goods. Be sure to know the answers before putting your home on the line.
Karen Lynch is a journalist who has covered global business, technology, finance, and related public policy issues for more than 30 years.
All Credit Intel content is written by freelance authors and commissioned and paid for by American Express.
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