The Pros and Cons of Cash-Out Refinances
Mar 28, 2016
In a cash-out refinance, you refinance your existing loan with a new larger loan and take out the difference between the two in cash.
For instance, say your home’s current value is $150,000 and you owe $70,000 on your mortgage. Refinancing your mortgage for $100,000 would leave you with an additional $30,000 to put toward other expenses.
According to Bankrate.com, mortgage rates continue to hover just under 4 percent, well below the historical average, so this may be a good time for homeowners with enough equity in their home to look into refinancing.
You May Have More Equity Than You Think
Homeowners might not realize how much equity may be available to them, notes Steve Deggendorf, director of business strategy in Fannie Mae’s Economic & Strategic Research (ESR) Group.
Research by Deggendorf and James Wilcox, a professor at the University of California, Berkeley, found that, while homeowners’ equity levels have grown as the U.S. housing market has recovered in recent years, many underestimate how much equity they have.
Analyzing data from Fannie Mae’s National Housing Survey and CoreLogic, the researchers found a mismatch between homeowners’ perceptions of their home equity and the likely reality. At the end of 2014, only 37 percent of mortgage homeowners surveyed in the NHS thought they had more than 20 percent home equity. But CoreLogic’s housing data indicated that roughly 69 percent of homeowners had significant home equity.
“It seems like a lot of people may have some misperceptions on the negative side about how much equity is available to them,” Deggendorf says, noting that this could prevent them from using instruments like cash-out refinances.
“Some people may be making poor decisions based on the fact that they see themselves being under water [on their mortgage],” he says.
Curiously, surveyed homeowners perceive that home values have risen, but this doesn’t seem to translate into a more accurate understanding of their home equity situation, Deggendorf says.
“Somehow there is this disconnect between home equity and home value in their minds,” he explains. “I don’t think we can say we understand it, but it seems like there is an opportunity to correct that misperception.”
He suggested that homeowners looking for an accurate assessment of their home’s value and, by extension, their home equity should contact a local real estate agent with an in-depth understanding of their specific market.
Of course, just because you have the equity doesn’t mean it’s a good idea to extract it. As NerdWallet.com notes, as with any refinance, you’ll have to pay closing costs, which typically run between 3 to 6 percent of the loan.
But for homeowners aiming to pay off higher interest debt like credit cards (while at the same time converting that debt to take advantage of available tax deductibility) or invest in education or property improvements that can pay off in the long term, a cash-out refinance could be considered.