Homeowners Taking Advantage of Their Equity

One of the benefits of owning a home is the opportunity to build equity. As you make your mortgage payments each month and, hopefully, your home steadily increases in value, you’ll slowly build equity. You can then tap that equity – often in the form of home equity loans or home equity lines of credit – to cover the costs of everything from home repairs to a child’s college tuition.

But there’s another way to tap the equity you build in a home, and that’s through a cash-out refinance. According to a recent story by REALTOR.com, homeowners are taking advantage of this opportunity in rising numbers today.

In a cash-out refinance, homeowners refinance their mortgage loans to ones with a lower interest rate, as usual. But they refinance for an amount greater than what they owe on their mortgages. They then take the difference in cash.

Say you owe $200,000 on your loan. You might refinance to a new loan of $230,000 and then take the extra $30,000 in cash.

According to the RealtorMag story, which cited numbers from Freddie Mac, nearly half of the borrowers who refinanced their homes during the first quarter of this year closed a cash-out refinance. Freddie Mac says that this is the highest level this percentage has been at since the fourth quarter of 2008.

To complete a cash-out refinance, you’ll need enough equity. Say you owe $210,000 on your mortgage and an appraiser determines that your home is worth $300,000. You now have $90,000 of equity. You’ll have enough equity to refinance that $210,000 loan into one of $240,000, taking the extra $30,000 in cash.

If you need money to pay a big expense, a cash-out refinance might work. But realize there are some drawbacks. First, you’ll get a slightly higher interest rate, on average, than you would with a standard refinance. You’ll also have to play closing costs, which can run $3,000 or more.

Most importantly, if your home loses value after you take out a cash-out refinance, you’ll be at a greater risk of becoming underwater on your mortgage, meaning that you owe more on your mortgage loan than what your home is worth.

Before signing up for one of these refinances, consider the pros and cons. You do have to be careful with your home.