3 Good Uses of a Cash-Out Refi

Here we discuss three of the best reasons to consider a cash-out refinance. When you combine a much lower interest rate with a good purpose for the funds, you stand to benefit greatly.

What Is a Cash-Out Refinance?

A homeowner who has built up equity can convert some of it to cash by replacing an existing home loan with a new, larger loan. The new loan rolls together what you currently owe on the home plus some cash. You could enjoy the primary benefits of any refi—a new lower interest rate, a lower monthly payment, or both—plus you get some cash. Smart uses for the cash include home repairs and improvements to raise value.

Some lenders promote cash-out refinancing by painting a picture of your house as a giant ATM. They make it seem like the homeowner is merely making a withdrawal. The reality is not that simple or cheap. As with regular mortgage refinancing, cash-out refinancing incurs closing costs. Also, because the cash amount was rolled into the new loan, you will have to pay interest on it. You should weigh these costs, along with a possibly higher monthly payment, against the plans you have for the cash.

1️⃣ Swap Your Higher-Rate Mortgage for One of Today's Low Rates

Uncertainty in the housing market has kept interest rates low for months. For most of 2020-2021, each week it seems that we saw headlines about rates dropping to previously unheard-of levels.

Rates change almost as fast we can put out articles like this. Today the average rate on a 15-year fixed-rate refinance is 3.46% according to MSN. A week ago the average rate was very slightly more, at 3.48%, making this the only loan type to drop over the seven days. Such a low rate could be life-changing to someone who took out a mortgage before the housing crisis in 2008, when the average fixed rate on a 30-year loan was 6.23%. Imagine switching from 6.23% to 3.46% for the last 15 years of your mortgage!

Lenders who respond to a daily survey conducted by Mortgage News Daily give us a good snapshot of current rates on different loan products. Average rates as of today:

Such low rates usually bring out homebuyers in droves. You would expect to see house hunters checking out homes and getting preapproved with lenders if it weren't for the coronavirus pandemic. Many Americans were postponing home shopping for the duration, more comfortable staying put. And now housing inventory is very low, frustrating many people's house hunt.

Instead, lenders are increasingly hearing from people thinking about refinancing. Competition is high for those customers while new home buyers wait things out. Refinancing is currently up 192%, according to the Mortgage Bankers Association.

2️⃣ Money for Home Improvements

Many people are spending more time at home lately than they ever thought they would. We notice shortcomings in, say, the kitchen flow and counter space, or the limitation of sharing one tight bathroom, or drafty windows. Using the cash you get out of the home via a cash-out refinance is a good way to fund home improvements because past equity (the cash) helps invest in future equity (raising the home's value).

Which remodeling project gets you the most bang for your buck? The answer is surprising and boring. It's not tricking out a new gourmet kitchen or converting the master bathroom into a spa retreat. Nothing that glamorous. The most financially rewarding project is attic insulation, according to a survey by Remodeling magazine, which Realtor.com wrote about. For every $100 spent on attic insulation, you can expect to recoup $116.90 when you sell the home.

Small and smart projects can actually add more value to a property than bigger renovations. Plus, home improvements aren't just about what you can recoup when you sell; you have to consider the improvement in the quality of your home life too. Examples of such projects are as follows.

• Paint the interior or exterior
• Landscaping
• Replace the roof
• Build a deck or patio
• Replace exterior siding

Other options: Home equity loan or line of credit.

If your current home loan already has a great rate and therefore refinancing is less attractive, but you like the idea of harvesting some of your home's equity to pay for repairs and improvements, consider a home equity loan or a home equity line of credit. These are taken out separately from your current mortgage. Home equity loans often have much lower interest than credit cards and personal loans. Most home equity loans or lines of credit have minimal, or even no, closing costs.

Don't go into a cash-out refinance if the payment on the new, larger loan could be hard to make. Be certain that you can pay off this loan in full and on time, or you risk losing your home.

3️⃣ Get Better Terms or Escape a Scary ARM

Another reason for a cash-out refinance is that you could move to a loan with more favorable terms. Moving from an adjustable rate to a fixed rate puts more solid ground beneath homeowners' feet because they don't have to worry about their monthly payment increasing later, and later still.

A refinance also lets you consider the length of the loan and to take advantage of your timeline. With around 15 years left on your mortgage, it makes sense to refinance at today's lower rates and replace the old mortgage with a new 15-year mortgage. See the table above for just how much lower the interest rates are on 15-year fixed-rate loans compared to the more common 30-year term.

Why keep paying the second half of a 30-year loan at 2007 rates when you could save on interest and monthly payments with a new 15-year loan at low 2022 rates? At some point in the new loan your savings will break even with the cost of the refi, and from that day forward you enjoy pure savings.

With around 15 years to go on your current mortgage, you might be closer to a potential home selling date too. Any shortcomings of the home are in sharper focus for you. The cash you get in the refinance could be put to good use on the projects you know are most important for your continued enjoyment of the home and its potential value to a new buyer.

One of the best reasons to refinance is to get away from an unpredictable adjustable-rate mortgage (ARM). If you can do this while also getting out some cash, all the better. With an ARM, it's scary to know that your monthly payments could go up; financial planning is more difficult. Life is unpredictable enough without having a question mark looming over your mortgage payments because of the changing nature of an ARM.

Takeaways

• A cash-out refi could supercharge your mortgage at an amazingly low new interest rate.
• A smart use of the money is home repair, thus preserving home value. This is not mad money to spend on vacations and gadgets.
• If you currently have an ARM, refinancing to a fixed rate can bring you peace of mind.