Remember the Mother Goose rhyme about the old woman who lived in a shoe? That is so 18th century. Today she would live in a piggy bank, and so would her neighbors.
Homeowners today treat their houses like piggy banks, readily transforming their equity into cash and credit. You have home equity loans (still sometimes called second mortgages), home equity lines of credit and reverse mortgages. Then there's cash-out refinancing.
Cash-out refinancing explainedWith cash-out refinancing, you refinance your mortgage for more than you currently owe, then pocket the difference.
Here's an example: Let's say you still owe $80,000 on a $150,000 house, and you want a lower interest rate. You also want $20,000 cash, maybe to spend on your kid's first semester at Princeton or to consolidate your other debts. You can refinance the mortgage for $100,000. That way, you get a better rate on the $80,000 that you owe on the house, and you get a check for $20,000 to spend as you wish.
Cash-out refinancing differs from a home equity loan in a few ways:
- A home equity loan is a separate loan on top of your first mortgage; a cash-out refi is a replacement of your first mortgage.
- The interest rate on a cash-out refinancing is usually, but not always, lower than the interest rate on a home equity loan.
- A refinancing means you have to pay closing costs; you don't have to pay closing costs for a home equity loan. Closing costs can amount to hundreds or thousands of dollars.
Is cash-out refinancing right for me?So, if you want to extract a chunk o' change from your three-bedroom piggy bank, how do you decide whether a cash-out refi is right for you?
It depends on how much you would save each month and what you want to spend the money on.
Let's take the example of the mythical Jack and Jill Bankrate. They took out a $100,000 mortgage on a $130,000 house in early 1992. Their interest rate was 9.95 percent, making their monthly payment $873.88 (plus taxes, insurance and other extras).