What Is a Cash Out Refinance Loan?

Written By Melanie Green
Last updated September 28, 2021

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September 28, 2021

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When homeowners run into financial problems, they look for ways to get cash out of their property and investments. Most people have most their net worth tied up in their houses. A cash out refinance loan can be an effective way to get cash by leveraging the equity in your home. However, you have to have a strong understanding of how it works since it uses your house as collateral for the loan. In this article, we explain what a cash-out refinance loan is and how you can use it to address financial problems.

A cash out refinance loan is a mortgage refinance that allows you to extract the equity in your house to use as cash. What is a cash out refinance loan? Put simply, it is a common way for homeowners to get cash to handle financial problems. You can use the money for whatever purpose you want. The lender will verify that you need the money for a legitimate purpose. This is done by checking your credit reports. Also, asking you about your financial situation, and comparing what you are doing to similar people. The goal is to make sure that you are financially stable and can continue to pay your mortgage.

When you buy a home, you likely took out a mortgage to pay for it. Most people do not have the money saved for a substantial payment for a house. Instead, you likely financed it over the next 30 years.

Value of Property Increases

While your mortgage decreases over time, the value of your property likely increases. As this happens, you gain equity in your house. Equity is the value by which your property has increased in value over time. For example, buying a $100,000 house that goes up in value to $300,000 in over 10 years means that you have $200,000 in equity. If you run into financial problems, you can use that equity to acquire cash and pay your debts.

Taking Equity Out of Your House

A cash out refinance loan lets you take the equity out of your house. Essentially, you take out a loan that is worth the equity on your house plus the remaining value of your mortgage. On that same $100,000 house that is now worth $300,000, you could get a loan worth $200,000. In addition to whatever is left on your mortgage. You use that money to pay off your mortgage and use the rest for financial obligations elsewhere.

In a cash out refinance loan, you do not have to take the full amount of equity out of your home. That is the maximum amount that you can take. You can take any value less than that in the loan. However, you have to pay off your previous mortgage and leverage your house again for the new loan. In essence, you are taking a second mortgage out on your home to pay off the first one and keep any cash that is leftover.

A cash out refinance loan can be an effective way to handle money problems if used correctly. One of the biggest problems with it is that you are increasing the amount that you owe on your home by borrowing money against it. You will owe more money to pay off your house than you did before you took out the loan. Which can be problematic if your money problems are not resolved.

If you are going to take a cash out refinance loan, be sure that you can resolve your money issues with the equity cash quickly. Failing to get your finances under control puts your house at risk, and you will have loan payments to make.

The most common reason for getting a cash out refinance loan is to consolidate debt. For example, if you have multiple loan payments on car loans, credit card bills or student loans, this can reduce the amount of interest you pay on those loans. People may also use the refinance loan to pay down existing home equity lines of credit or other outstanding loans.

It may be tempting to take out a cash out refinance loan if you run into financial trouble. But there is no need to rush into it. You should hold out and try to resolve your money issues with other avenues before turning to your house as leverage. A cash out refinance loan can help you resolve some serious financial problems. But it is not the best choice for handling all of them.

When you consider taking out a cash out refinance loan, it is important to know how much you are going to spend. You are probably going to make payments on your existing loan for the duration of the loan. If you are not making payments now, you will need to make them now if you want to keep paying them off over the next twenty years.

You should budget out how much money you would have left after your home equity line is paid off. That is the amount that you can use to pay off debts or get cash. You should also budget for the portion of your home equity that will go toward interest.

A cash out refinance loan requires more than just having cash on hand. The amount that you can borrow is determined by a couple of factors, including your credit rating, your debt to income ratio and the remaining value of your property.

If you have a low credit score, this will put your ability to get the maximum amount of cash out of your home at risk. The lender will check your credit. This will determine how much you can borrow, so if you are behind on payments now because of money issues, the lender may limit the amount that you can borrow.

Debt to Income Ratio

You also have to consider anything else that could affect your ability to get cash. For example, if you have a lot of outstanding debt or a high debt to income ratio from taking out a second mortgage. The lender will probably limit the amount that you can borrow.

If you have a very large home equity line of credit and money is not a problem for paying it off immediately, the lender may also limit the amount that you can payout. You should look into all options before rejecting a cash out refinance loan because it is not giving you as much as you want.

A cash out refinance loan can be a great way to address your financial problems. But you need to have a plan before you take it. Just like your mortgage, you are putting your house at risk. Without a way to solve your money issues and start paying off the loan, your problems will only get worse.

If you are asking, “what is a cash out refinance loan?”, talk to a financial advisor about your options before you make a financial decision. Getting advice from an independent financial representative can show you unbiased ways of addressing your financial concerns.

About the Author

Melanie Green

I'm a professional freelance writer living in Tampa, FL. I've been freelancing full-time since 2012, maintaining key relationships with my clients through always aiming to exceed their expectations. I have an MFA in Creative Writing with a concentration in screenplay writing from National University, as well as a Bachelor of Arts in Writing. I love writing about a wide range of topics including movies, technology, food and business marketing.

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