You May be Sitting on $158,000 of Tappable Equity

House prices in the U.S. have risen 12.6% in just a year, making many Americans house-rich, to the tune of $7.3 trillion in tappable home equity, according to mortgage technology and research firm Black Knight. This is the largest dollar value gain in history — about $158,000 per homeowner with tappable equity, a total of roughly 18 million people.

Combined with the fact that interest rates have remained at or around historic lows of 3% for months, a cash-out refinance right now could help you not only access a large lump sum of cash, but also lower your monthly payments. That extra money can then be put towards home renovations or paying down high-interest debt such as student loans and credit cards.

Yes, Now Is A Good Time for a Cash-Out Refinance

Current mortgage rates indicate that now is a good time to refinance your home, especially as the window for low rates may slowly be closing.

Increases have been forecast by various groups, including Fannie Mae and The Mortgage Bankers Association (MBA). The former anticipates that by the end of 2021, rates will rise to 3.4%, while the latter predicts an increase to 3.7%. While it’s certainly feasible that rates might drop below 3% again in 2021, this may not necessarily be the norm. Even with these increases, averages are far better than those from past years. Rates during the 2010s averaged 4%, with 2019 averaging 4.4% for 30-year mortgages.

For the time being, a cash-out refi can still help you take advantage of soaring home prices and rock-bottom rates. This might be a great time to rethink your finances and find a mortgage refinance lender.

What is Cash-Out Refinance?

A cash-out refinance is a way to replace your current mortgage with a new one under new terms, for more than your current mortgage balance, as you get an additional lump sum of cash in the process. The new loan replaces your existing mortgage and you receive the difference between your old loan and your new loan (minus any applicable costs) in cash.

With conventional or FHA loans, lenders typically let you borrow up to 80% of your home’s value. For VA loans it can be up to 100%.

Why Should I Get a Cash-Out Refinance?

Lower interest
The purpose of refinancing, in general, is to save money. That means securing a lower interest rate on your new mortgage loan and, as a result, lower monthly payments. Although a cash-out refinance has higher rates than traditional rate-and-term refis, with rates near historic lows it's still possible to get a lower interest than your existing mortgage. These currently also boast better rates than home equity loans.

Pay off high-interest debt and debt consolidation
Credit card debt is a high-interest obligation that can quickly balloon to unmanageable levels. Under the right circumstances, paying it off with a cash-out refi can alleviate the immediate financial crunch.

Nonetheless, using your lower-interest home equity to pay off outstanding debt is not necessarily the wisest choice, since the repayment term is spread out over a longer period (say, 30 years). Even with its higher interest, you might be able to pay off credit card debt sooner and pay less total interest.

College tuition or student loans
With the ever-rising costs of higher education, money from a cash-out refi can be used to pay you or your relative’s college tuition without having to enter into the higher-interest debt of a private student loan or a federal parent PLUS loan.

Home improvements and repairs
One of the most common reasons for securing a cash-out refinance is for home improvements, upgrades, and repairs, which can help you twofold.

First, when done right, updating key areas of your home, such as the bathroom or kitchen, will often increase its value, thereby increasing your equity. In this situation, the refi almost pays for itself. Second, if you use the cash to improve your home you may be able to deduct additional interest payments from your taxes.

“Homeowners with sufficient equity can take advantage of the current historically low interest rates to secure tax-free cash for projects that can increase the value of their home,” says Bill Banfield, executive vice president of capital markets for Rocket Mortgage.

Why Should I Avoid a Cash-Out Refinance?

Possible high, up-front closing costs
Some lenders will fold any closing costs or fees into your monthly mortgage payments or you could pay the closing costs upfront. These closing costs can vary between 2-5% of the loan amount, meaning a $150,00 cash-out refi requires a $7,500 out-of-pocket expense.

High break-even point
As mentioned, it’s important to calculate the break-even point in order to determine whether refinancing is right for you. High-break even points don’t provide the financial relief needed to justify cash-out refinancing, particularly if you’re thinking of moving within that time frame.

Foreclosure risk
No matter the purpose for which you decide to refinance, you’re going to be putting your home at risk if you ever default on your payment.

This is especially true if you’re using your cash-out refi to pay off credit card debt, as you’re basically exchanging unsecured debt for secured debt. Missing payments on a credit card can lead to penalties, credit score damage, and collections. However, defaulting on your mortgage can lead to foreclosure and the loss of your home.

A cash-out refinance also lowers your home equity, thereby increasing your risk of owing more than the home is worth if its value ever decreases.

Using the money for non-essentials
Even though a cash-out refinance provides tax-free cash, it’s not usually recommended for large purchases or expenses such as a new car or vacations for the same reason mentioned above: risking foreclosure to pay for a luxury or non-essential item is not a wise financial strategy.

Additionally, going through a cash-out refinance is basically the same as the original home buying process, with an appraisal and an underwriting period that can take a few months to complete. “If homeowners need money immediately, a cash-out refinance may not be the right solution,” adds Banfield.

Is a Cash-out Refinance Right For Me?

Whether or not a cash-out refinance is a good idea for you will always depend on your risk tolerance, financial situation, and existing mortgage terms. While the current low interest rates may make your new mortgage payment considerably lower, you may not be able to qualify for the best rates. This will depend on several factors, including your credit score, DTI (debt-to-income) ratio, and a maximum loan-to-value ratio (LTV). Our mortgage refinance calculator can help you find out what your potential mortgage loan rates might be right now.

Lenders will also require payment documentation, evidence of income, and a recent home appraisal (within the last 90 days). Homeowners considering a refinance must have made at least six consecutive payments to their original loan. For a cash-out refinance on an FHA loan, homeowners need to reside in the home for a minimum of 12 months.

Finally, as with any mortgage refi, you'll also need to consider the break-even point, or the time it'll take for your monthly savings to equal the costs of securing this new loan.

Say you refinanced your mortgage to save $250 per month, but the process ends up costing you $5,000. How long would it take to recoup that 5k? Divide 5,000 by 250 and you get 20. It will take you 20 months to make back the costs of refinancing, the break-even point. Everything after that is direct savings.

Summing up, the right call for refinancing depends on your circumstances, including your personal finances, current loan rate, and how long you plan to stay in the home.