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. 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 (a.k.a. your equity in the property, which is its value minus the debt owed). The difference between your old and your new loan is given to you in cash, after any fees or associated closing costs. Simply put, however much money is left over after you pay off your old home loan with your new home loan is yours.

For example, say the principal of your current mortgage was for $300,000, but you have since paid off $80,000 (or you live in a swanky neighborhood and the value of your home has increased by $80,000, or any combination of the two). You could take out a cash-out refinance, leaving you with up to $80,000 in extra cash to catch up on debt or pay for other expenses. This is especially useful if you are paying high interest on those other debts. Credit card interest rates are typically around 15–25% APR compared to today’s 2–3% average interest rates for mortgages.

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/or 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. If you bought your home within the last decade, there’s a chance you can lower your rate in addition to accessing your equity. But even if your rate stays roughly the same, 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 save you a lot in the long run, and help you get off a frustrating debt treadmill.

Have you considered all your options?

Another loan isn’t for everyone. We get it. If you’re trying to set the world record for paying off your mortgage, or, more likely, you’re not interested in another long term financial commitment, there might be another way. Do you have family who can loan you enough to cover your credit card balance? Do you have stock, bonds, a vintage car, or collection you no longer want that can be sold for cash 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, like appraisal fees, title checks and insurance, and some of the same closing costs you paid when you took out your original home loan. If you’re eligible and the numbers work for you, you can roll your closing costs into the principal to avoid upfront costs, but, in this case, it does cost money to save money. Making sure those costs don’t outweigh the cash benefits is crucial.

There are more ways to access home equity

There are other ways to access your home equity. You can take out a Home Equity Loan (HEL). This is what most people are talking about when they say “I took out a second mortgage.” It’s a loan, like a mortgage, completely separate from your initial home loan based on the equity you’ve built over the past however-many years. You pay it off every month in addition to your original mortgage, so you will have to assume a new monthly payment, but chances are the rate will be far lower than the rate on your credit card, and there are fewer closing costs than your original mortgage.

There are also Home Equity Lines of Credit (HELOC). This operates similarly to an HEL, as in it’s a loan that’s completely separate from your current mortgage, but it’s different in that instead of a lump sum of cash, you’re given a line of credit you can draw on over time. You only pay interest on what you use and there are little to no associated closing costs.

There are a lot of ways to tap into your equity to help consolidate your debt, so 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.

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, so does your equity.

• 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. According to MagnifyMoney’s annual post-holiday survey, the average American racked up around $1,325 of gift-giving debt in 2019, and that’s on top of their already overwhelming average of $38,000 per individual (excluding mortgages).

• The 2017 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. And we’re always here to help. Head to our pre-approval to see if a cash-out refinance is right for you.

Disclaimer: This blog post is for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal or accounting advice.