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Cash-Out Refinancing: Another way to leverage home's equity.



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Cash-out refinancing is another way to get money for home improvement projects, investments, debt consolidation, college, or starting a business. A cash-out refinance involves the replacement of the existing mortgage(s) with a new, larger one. The difference between the old mortgage payoff and the amount of the new mortgage is the cash paid out, delivered to the borrower when the loan closes and funds. A homeowner who needs cash should first determine the amount of available equity in the home. Equity can be estimated by taking the current value of the property and subtracting the loans against it. Normally, lenders allow a higher loan-to-value ratio for second mortgages than they do for cash-out refinancing. So if there is insufficient equity the only option might be a second mortgage. Next, homeowners should take a look at their current mortgage interest rate and see if the terms on the existing mortgage can be improved. If so, the third step would be to use a mortgage calculator--like the many available online--and see if the costs of refinancing could be recouped during the time that the homeowner plans to own the property. If not, a low-cost second mortgage might be a better way to get needed cash.

Debt Consolidation and Other Uses

Cash-out refinancing can be a great way to turn high-cost debt into low-cost debt. Because the loan is secured by real property, mortgage financing is one of the least expensive ways to pay for anything. And there are no restrictions on the use of the funds. By consolidating high-cost debt and improving their mortgage interest rate, borrowers may be able to stretch their income further, get their finances under control, and correct overspending habits.

Disadvantages: Cash-out refinancing is considerably more expensive than taking out a second mortgage--the first option can cost thousands, the second a few hundred. Cash-out refinancing loan-to-value limits tend to be more restrictive than second mortgage limits. And it can be risky to move unsecured, high-interest consumer debt to a mortgage secured by hearth and home. If the homeowner becomes unable to make the higher mortgage payment, he or she may lose the home in a foreclosure.

Advantages: A cash-out refinance can be used for the same reasons as a traditional refinance: to fix an adjustable rate, lower monthly payments, add flexibility, or obtain a better interest rate. And the cash taken can be used for any purpose, from paying off debts to starting a family. Additionally, mortgage interest is probably tax-deductable (homeowners should verify this with a tax professional).

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