Should You Do A Cash-Out Refinance?

October 08, 2018

It seems like I have been hearing a lot more advertisements for the concept of a cash-out refinance recently (maybe I just noticed it more). Perhaps due to the recent tax law change that disallows the deduction of interest for home equity loans that aren’t used for home improvements? Either way, it got me thinking about the idea and I wanted to explore the pros and cons a bit further.

A cash-out refinance is when you refinance your existing home loan with a larger loan that uses the equity you have in your home to provide cash back to you at the time of closing. It’s basically a way for you to get access to your home equity without having to sell it. Technically, you can use that cash for whatever you want, but the most common uses include:

  • Home improvements – using equity to make improvements to your home can add to the home’s market value and be a sound investment. Be careful here though – make sure the improvements are things future buyers will value, and not things only you and your family will enjoy.
  • Education – pursing a new degree or certification may help you earn a higher salary and benefit you in the long run. If you are confident that is the case, then pulling cash out of your home may make sense.
  • Business opportunities – while it may be tempting to use cash from your home to start a business or get in on that “once-in-a-lifetime” opportunity your neighbor told you about, be careful here. It is hard to make a business work long-term, and you need to make sure you can repay your loan if the venture doesn’t pan out.
  • Pay off credit cards – this seems to be the one mentioned most on the advertisements I’ve been hearing. And it makes sense on the surface – pay off high interest debt with a much lower interest rate and get that credit card monkey off your back. While getting out of credit card debt is important, using equity in your home to do it does put your house at risk if you default on your mortgage. Adding that risk to the decision is important.

Advantages of a cash-out refinance

If you are considering a cash-out refinance, it is understandable as to why. While interest rates have been creeping up in recent years, perhaps you can still lower your rate AND accomplish another goal at the same time. After all, using your home equity lets you:

  • Access a considerable sum of money – you may have tens, or even hundreds, of thousands of dollars in equity built up in your home.
  • Borrow at low interest rates – even with interest rates rising, mortgage rates are still much lower than personal loans, and certainly credit cards.
  • Repay it back over a longer time – your new mortgage can be for 15 or even 30 years, so you can really stretch that out. See below for thoughts on why that may not be such a good thing though.
  • Retain the ability to deduct the interest – the new tax law eliminated the interest deduction for home equity loans used for anything other than home improvements, but when you do a cash-out refinance, it’s the primary mortgage on your house, so you can still deduct all the interest you pay on the first $750,000 of indebtedness even if you use that cash for other purposes.

Disadvantages of a cash-out refinance

As with all things it seems, there are pros and cons to consider with a cash-out refinance. Some of the downsides to keep in mind include:

  • Interest costs – refinancing generally means you re-set the clock on the mortgage term. This increases the total interest that you end up paying over the life of the debt. So, if you use cash to pay off credit cards, you may end up paying off that debt for up to 30 years.
  • Closing costs – a fact of life with a mortgage loan. Whether you roll them into the loan or pay them up front, they are real, and they can be significant – sometimes thousands of dollars.
  • Putting your house at risk – your mortgage bank uses your home as collateral for the loan. If you don’t make payments, you face losing your home through foreclosure.
  • Your payment will go upThis calculator – unless you’re significantly reducing your interest rate, chances are your monthly payment will increase for the additional money you’re borrowing. can help you to run the numbers.

These issues often make a cash-out refinance a risk not worth taking. Of course, every situation is different, so my next post will focus on alternatives to the cash-out- refinance.