If you have a lot of equity in your home – that is, you own a significant portion of your home – then you may consider: a Cash-out refinancing. With traditional refinancing, you swap your existing ones mortgage for a new loan and borrow the same amount that you owed on your original loan. With a cash-out refinance, you borrow more than your remaining mortgage balance and use the rest for anything from paying off high interest rates Credit card debt Education to pay.
In many cases, it pays to do a cash-out refinancing, especially when Refinancing rates are attractive. But be careful, because cash-out refinancing could lead to these dangerous pitfalls.
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1. Support frivolous expenses
Cash-out refinancing is extremely flexible. The money you get from one can be used for whatever you want – but that’s not necessarily a good thing. If you owe money on a credit card that charges you 20% interest or a personal loan that charges 8% interest, and you are entitled to 3.5% interest on a payout refinance, then it pays to go this route to go. You can use the extra money you get from your mortgage to consolidate that debt and pay it off at a much lower interest rate.
On the flip side, the money you get from a cash out refinance could just as easily be used on a luxury vacation. And that’s the kind of thing you shouldn’t be doing unless you’ve saved up for it. In fact, a payout refinance could result in spending that is too careless for your own good.
2. Increase your risk of foreclosure
When doing a cash out refinance, you take out a larger home loan. And the higher that loan, the higher your monthly mortgage payment. This increases the risk of falling behind and losing your home in the process.
Of course, a payout refinance doesn’t automatically mean you’ll be in arrears, and your monthly payments may not go up too much if you don’t take too much cash out of your home. You may even be able to get a much lower interest rate on your loan than you paid before. But it’s a concern that should be on your radar.
3. Accumulate expensive closing costs
When you refinance a mortgage, you have to pay Closing costs which are calculated as a percentage of the amount you borrowed. The higher your loan amount, the more money you will spend to complete your new home loan.
Closing costs vary depending on Lender, but are usually 2 to 5% of your loan amount. If you owe $ 100,000 on your mortgage but cash out refinance for $ 120,000, you could end up paying a 5% closing cost on that additional $ 20,000. That equates to $ 1,000 in closing costs for that portion of your new mortgage alone.
There are many situations in which cash-out refinancing makes sense. But if you are thinking of making one, make sure you really understand the risks and disadvantages involved.