A guide to cash-out refi:/ using your home to consolidate high-interest debt

With a PhD in financial economics, Sean Hundtofte is here to help you understand how macro and micro economic forces affect homeownership — from homebuying to real estate to refinancing and beyond. A former research economist for the Federal Reserve Bank of New York, Sean’s goal is to help you make more informed decisions about homeownership.

While the holiday season is the most festive time of the year, it also tends to be the most expensive for people. If you’re wondering, “How do I lower my debt costs after the holidays?” you’re not alone.

A cash-out refi could be a smart and cost-effective way to consolidate past expenses, like holiday spending, while simultaneously improving your financial situation. Here’s everything you need to know.

What is a cash-out refi?

A cash-out refi is a type of loan where you refinance your home mortgage, and in the process, extract money out of your home’s value (aka your equity in the property, which is its value minus the old debt) by taking out a new loan. The difference between your old and your new loan is given to you in cash, after any fees or associated closing costs.

For example, say you owe $200,000 on your home and had a low amount of debt to start with, or its value increased to $300,000 since you first bought it. You could take a cash-out refi leaving you with up to $100,000 in extra cash to catch up on debt or pay for other expenses. This is especially likely to be useful if you are paying high interest on those other debts. For example, credit card debt is typically at 15–25% APRs compared to today’s 4–5% interest rates for mortgages.¹

Who benefits most from a cash-out refi?

A cash-out refi isn’t for everyone. Ask yourself the following questions before taking the leap.

How long have you lived in your home?
For a cash-out refi, you’ll need to have a decent amount of equity in your home. Equity can be built slowly over time or more quickly through renovations or an increase in local house prices and values. Most lenders will require you to have made at least two years’ worth of payments and have a minimum of 20% equity.

What are my interest rates?
When did you buy your home? If you bought during the housing crisis, you could already have an incredibly low interest rate. But even if you can’t get a lower interest rate on your mortgage, you could save on interest by paying off other debts that have higher interest rates. Transferring debt from high, unsecured, interest rates to low, secured, interest rates could be financially optimal. Learn more about reasons to refinance, even when rates are rising.

Have you considered all your options?
If paying your home off in record time is an important goal for you, a cash-out refi can slow you down. Do you have family you can take a loan out from? Do you have assets you no longer want that can be sold or assets used to pay off debt? Consider all your options before deciding refinancing is right for you.

When is the best time for a cash-out refi?

So, you meet a lender’s requirements and know that a cash-out refi is a good option for you. Now let’s dive a little deeper into cash-out refinancing.

The benefits should outweigh the costs
A cash-out refi will always have associated costs, and a lot of these are fixed costs, i.e. they need to be paid no matter the size of the loan. Making sure those costs don’t outweigh the cash benefits is crucial.

For this reason, cash-out refis rarely make financial sense for small amounts of cash that you’d like, or are able, to take out. Reevaluate the estimated equity in your home (its current value minus the old mortgage) periodically to see if refinancing should be considered. Just because it didn’t make sense last year doesn’t mean it won’t this year.

There are other options
A cash-out refi is only one traditional option for accessing your home’s equity. A HELOC, or Home Equity Line of Credit, is a fixed line of credit often considered by homeowners. But because of a HELOC’s shorter terms, the higher rates and additional monthly payments can cancel out potential interest savings compared to a cash out refi.

Another major advantage of cash-out refis over HELOCs is a potential tax benefit. In most cases of debt consolidation, a second lien HELOC will not provide you with tax deductibility after the recent tax reform, leaving the first lien cash-out refi as a superior option for potential tax savings.

Debt consolidation doesn’t have to be a nightmare

Still have concerns? Despite the precautions listed, now might be a good time for a cash-out refi. Here’s why.

• When home prices increase, this tends to mean home equity you can tap into.
• With incomes staying stagnant in several industries, and an increase in consumption, some people may find themselves in need of cash, especially around the holidays.
• You’re not alone if you’re facing buyer’s remorse before the gifts are even opened. Most Americans add at least $1,000 of debt² to their already overwhelming average of $38,000³ per individual (excluding mortgages) during the gift-giving season.
• The recent tax reform has limited homeowners’ options when it comes to using home equity. This means a cash-out refi with a first-lien mortgage may be helpful.

You always have options and choices in how to manage your debt responsibly. To learn more about using a mortgage to consolidate high-interest debt, give Better Mortgage a call today.