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.
With 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 child's first semester at Princeton. You can refinance the mortgage for $100,000. Ideally, 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.
- A home equity loan is a separate loan on top of your first mortgage.
- A cash-out refinance is a replacement of your first mortgage.
- The interest rates on a cash-out refinancing are usually, but not always, lower than the interest rate on a home equity loan.
- You pay closing costs when you refinance your mortgage.
- Generally, you don't pay closing costs for a home equity loan.
- Closing costs can amount to hundreds or thousands of dollars.
It doesn't make sense to refinance a higher amount at a higher rate. If your current mortgage is at a lower interest rate than you could get now by refinancing, it's probably better to get a home equity loan. Or, if you're 20 years into a 30-year mortgage, you're paying more principal than interest with each mortgage payment, says Nancy Flint-Budde, independent Certified Financial Planner in Salem, N.Y. "If you are that far into a loan, then it might not make sense to refinance, even if your current rate is slightly higher."
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.