Most homeowners are aware they can do a cash-out refinance on their homes. But what they may not be entirely aware of is how many beneficial uses there are for the funds from a cash-out refinance. And with the recent surge in house prices in most markets across the country, homeowners are sitting on a lot of untapped equity.
There are a variety of ways you can use that equity – through a cash-out refinance – to improve the quality of your life and your finances.
Making Improvements to Your Home
This is the classic purpose for funds from a cash-out refinance. You’re borrowing on the home, then reinvesting the funds to improve it.
This can include everything from adding additional space, such as a full-on addition to the property, to performing general renovations. For example, periodically it’s necessary to update your home, particularly the kitchen and the bathrooms. Those are the rooms that add the most market value to your home, and they need to be renovated about every 15 years or so.
You may also decide to expand living space without adding an addition. This can include converting an enclosed porch to permanent living space or finishing your basement. And though it’s not recommended by real estate agents, some homeowners choose to turn their garage into additional living space.
Since renovations and additions generally increase the value of the home, taking on the additional debt often maintains your original home equity position. It’s perhaps the best single use for funds from a cash-out refinance.
Paying Off Non-Housing Debt
While it’s generally not recommended that you use home equity funds to pay a non-housing debt, it can seriously improve your overall financial situation.
For example, let’s say your home is worth $400,000. Your original first mortgage of $320,000 was taken eight years ago, with a 30-year mortgage at 4.25%. Your current payment is $1,574, and the remaining balance is $250,000.
You have a $30,000 car loan with a $600 per month payment, and $40,000 in credit card debt, at $800 per month. Totaling all three debt obligations – mortgage, car loan and credit card payments – your total monthly debt is $2,974.
You decide to do an 80% cash-out refinance on your home, which brings the new mortgage back to $320,000. At an interest rate of 4.25%, and a loan term of 30 years, your monthly payment remains $1,574. But your car payment and your credit card payments, at $1,400 per month, are now gone.
All the obligations you had before doing the refinance are now rolled up into a single payment – your new mortgage payment.
If you can avoid incurring new debt going forward, your financial situation will have improved dramatically, and all as a result of a single transaction – a cash-out refinance.
Financing Your Child’s College Education
Student loan debt in America has reached $1.5 trillion in 2018, and it’s growing by nearly $100 billion per year. Many young adults are burdened by student loan debts they can barely afford while they try to establish themselves in life.
One of the best workarounds to student loans is using a cash-out refinance on your home to pay at least some of your child’s college education costs.
If you have a significant amount of equity in your home, you may be able to borrow as much as $50,000 to $100,000 or more in cash. That can go a long way toward financing your child’s college education.
Meanwhile, the interest rate on the new mortgage will almost certainly be lower than what your child will pay on typical student loan debt. And since you’ll be spreading those payments out over the 30-year term of your mortgage, they’re likely to be lower than a standalone student loan payment.
Buying Other Real Estate
This is a less common way to use funds from a cash-out refinance, but it’s one that makes a lot of sense.
Basically, you’re using the equity in your home to purchase additional real estate. Even though you’re increasing the indebtedness on your home, you are in effect maintaining overall real estate equity with the acquisition of additional property.
For example, let’s say your home is worth $400,000, and you owe $250,000 on the current mortgage. You do a cash-out refinance for $300,000, using the extra $50,000 as a down payment on another property. It could be either a second home or an investment property.
The $50,000 is used as a 20% down payment toward the purchase of a $250,000 second home.
Before you did the cash-out refinance, you had $150,000 equity in your primary residence. After the refinance, your equity in the home is down to $100,000. But you’ve replaced it with $50,000 equity in the second home.
That means your total real estate equity will remain the same at $150,000, despite the cash-out refinance. The equity is just spread across two different properties, rather than one.
Some would even say that’s an excellent investment diversification strategy!
Any Purpose at All
You should never be casual about how you use the equity from your home. But there generally are few restrictions on how you can do it. For example, you can use the equity to purchase a car, instead of using a car loan (though it isn’t recommended).
You can also use the funds to pay for medical costs. In today’s health care situation, where copayments, deductibles, and coinsurance provisions are rising steadily, it’s possible to incur thousands of dollars in medical debt. Tapping into the equity in your home could be a viable way to cover those costs, without crushing your household budget.
Still another possibility is to borrow against your home to start a business. Many businesses require a significant amount of money up front. If most of your wealth is tied up in your home or your retirement plan, doing a cash-out refinance against your home may be the most efficient way to come up with the capital.
After all, liquidating retirement funds usually requires payment of income tax on the amount withdrawn, as well as a 10% early withdrawal penalty if you’re under age 59 1/2. And even if you’re able to take a loan against your retirement plan, it will generally have to be repaid in no more than five years. That will result in high monthly payments.
Once again, you have to be careful how you plan to use the funds from a cash-out refinance on your home. But if the funds can be used in a way that will provide a long-term benefit to you and your family, it’s always worth investigating.