- A cash-out refinance lets you borrow against your home equity and put the cash toward other financial goals.
- The median home price in the US increased from $329,000 to $408,100 over the course of the pandemic, giving homeowners a lot of equity to tap into.
- Now could be a good time for a cash-out refinance, because home prices are going up while mortgage rates are still relatively low.
- Read more from Personal Finance Insider.
Mortgage rates are rising and, as a result, fewer Americans are interested in refinancing.
However, homeowners are also sitting on a lot of equity right now, thanks to the breakneck home price growth that defined the pandemic housing market.
In Q1 2020, the median home price in the US was $329,000. As of Q1 2022, that number has jumped to $408,100, according to data from the Census Bureau and the Department of Housing and Urban Development.
Because homeowners have gained so much value in the past couple of years, many are in a good spot to take advantage of their equity with a cash-out refinance — even as rates continue to rise.
How does a cash-out refinance work?
Like a rate-and-term refinance, a cash-out refinance replaces your current mortgage with a new one. With a cash-out refinance, however, you’ll borrow more than what you currently owe on your mortgage and pocket the difference. In most cases, you can borrow up to 80% of your home’s value. Here’s an example of how that might work:
Your home is worth $300,000, and you still owe $150,000 on your mortgage. You decide to get a cash-out refinance for the full amount you can borrow, which is $240,000 (or 80% of $300,000). Once you’ve paid off your current mortgage, you’ll be left with $90,000 (240,000 – 150,000 = 90,000), minus closing costs. Those leftover funds are yours to use as you wish.
Mortgage rates are increasing, but they’re still relatively low
Typically, it only makes sense to refinance your mortgage if you can get a lower rate than what you’re currently paying. Rates are higher now than the last two years’ all-time lows. But they’re still below their 2018 peak, when they nearly surpassed 5%, according to Freddie Mac data.
Plus, even as rates rise, a cash-out refinance is often cheaper than other options, says Melissa Cohn, regional vice president of William Raveis Mortgage.
“Mortgage rates are significantly lower than credit card debt or other types of loans,” Cohn says.
For example, while national mortgage rates are still below 5%, many people pay well over 10% interest on credit card debt. And the lower your credit score, the higher your credit card interest rate could be.
Homeowners gained a lot of equity during the pandemic
One big reason why cash-out refinancing may still be beneficial for homeowners is that, after two years of rapidly rising home values, this group has a lot of equity available to them.
Because market conditions have gifted homeowners with what essentially amounts to free money, it may make sense to tap into some of that wealth and use it to improve your financial situation, either by reinvesting it into your home or consolidating high-interest debt.
Sonu Mittal, head of mortgage at Citizens Bank, says he often sees people use cash-out refinancing for things like home improvements, debt consolidation, or to cover large purchases.
“People can use the cash for any of their financial needs,” Mittal says. There aren’t any rules about how you can spend the money.
Though home renovations usually don’t completely pay for themselves, the right ones can help increase your home’s value to a certain extent and increase your own enjoyment of your home.
A cash-out refinance may be cheaper than other options
Cash-out refinancing lets you borrow money at a relatively low interest rate and pay it back over a long period of time.
Alternatives to cash-out refinancing include home equity loans or home equity lines of credit, personal loans, or credit cards. The best option for your situation depends on how much you need to borrow, how fast you think you’ll be able to pay back the funds, and how much you’ll pay in interest and fees.
“If you are looking to use the proceeds from cash-out refinance in the near future for a home renovation, debt consolidation, or another life-changing event and don’t expect to pay it off or pay it down materially in two to three years, fixed-rate mortgages allow you the peace of mind and reduce the impact on your monthly cash flow given you can amortize it over 30 years,” Mittal says.
The bottom line: If you can get a cash-out refinance with a lower interest rate than with your other loan options, and you have enough equity in your home, it could be a smart move.