When Cash-Out Refinancing Makes Sense

Back in the pre-recession days -- say, four or five years ago -- "cash-out" refinancing was all the rage. This move can still make sense, but there are often better alternatives.

The cash-out refi is simple: Say your home is worth $400,000 and you owe $250,000. Since lenders typically allow mortgages as large as 80% of the property's value, you could take out a new loan for $320,000 and have $70,000 left after paying off the old loan.

Real Estate
Homeowners may be tempted to use cash from a refinancing for a short-term need, but there are a few points to keep in mind first.

With today's 30-year fixed-rate mortgage interest rate down to a mere 4.4%, you could use that cash to pay off high-interest credit card debt, remodel your home or for some other purpose.

But keep a few points in mind.

First, it's generally unwise to take on long-term debt for short-term needs. A 4.4% mortgage rate is a terrific deal for buying a house, which is a long-term holding, but over 30 years you'll pay about $800 in interest for every $1,000 borrowed. If you bought a $30,000 car on those terms you'd pay $54,000 in interest and principal over the life of the loan. You'd still be paying long after the car was worthless.

Second, add in the costs of taking out the loan. Things such as title insurance and application fees can come to 3% to 6% of the loan amount. That's OK if the refinancing reduces your mortgage rate substantially, as the saving will offset the costs in a few years.