Q: “With mortgage rates so low, I’m thinking about refinancing to get a lower interest rate, and using some of the money to pay down some credit card debt (about $10,000 worth). A friend of mine told me about cash-back refinancing, which allows you to refinance, but get extra money back. Is that the real deal?” – D. Tricarico, San Diego, Calif.
A: The short answer is yes: Cash-back, or cash-out, mortgage refinancing deals do exist, and you can get money out of the loan to pay down some extra debt.
On the surface, it seems like a good idea. If your credit card interest rate is, for example, 10%, and your refinancing rate is 5%, you’ll actually save money if you pay down your card debt from the mortgage loan.
But that only works if you pay back the mortgage loan – without fail – each month. You are, after all, assuming more debt (via the refinancing deal) and any payment you miss can significantly (and negatively) impact your credit score.
How do cash-back refinancing loans work? It’s not that complicated, actually: With a cash-back refinancing, you get cash back at the loan’s closing. These loans work best when you have decent equity in your home.
Let’s say you owe about $50,000 on your 30 year fixed-rate mortgage loan, and that you have five years left on the loan. When you get a cash-out deal, you can get a $100,000 cash-back loan, use half of it ($50,000) to pay off the old home loan, and keep the rest ($50,000) for any purpose you want. You now owe $100,000 on your house, but at a lower rate than you were paying before.
Of course, what you do with the extra cash is the real issue here. You only need $10,000 to pay down your credit card debt so a more modest cash-back loan may be a good idea for you if you get a good rate, and have, as we said above, good equity in your home.
Your lender will provide guidelines on exactly how much home equity you have built up over the years. Depending on the lender, you can borrow anywhere from 80% to 125% of your home’s value. The Federal Housing Administration will lend up to 85% of the value in a cash-out refinancing, while the U.S. Veteran’s Administration and most major home equity lenders will give up to 90%.
Of course, you’ll need a good credit score to get such loan amounts (most loan-to-value deals are dependent on your credit score, along with your home equity situation).
As always, you’ll need to get all your ducks in a row to get that cash-back deal. Like any mortgage loan, you’ll want to shop around for the best offer. Start with the BankingMyWay Mortgage Rate Search - you should find plenty of good loan deals there.
Also, make sure you get your credit score in good health, and watch out for closing costs. Most are negotiable but you won’t avoid paying them.
Above all, any money you get in cash should be used to pay down high-interest debt like credit cards. If you squander the money on a new boat or a big vacation, obviously you’ll still have all your credit card debt hanging over your head, while at the same time owing more on your house.