Cash Out Refinance
When you refinance your mortgage on your home, or take out an equity line of credit with the intent to put money in your pocket, or pay for something else, you are doing a cash out refinance. Essentially you are tapping into the equity your built up in your home and making it liquid.
Cash out refinance and rate and term refinance differences
| Cash Out Refinance |
Rate and Term Refinance |
| Primary reason is to take cash out of the house for other uses |
Primary reason is to lower your rate, or your monthly payments by re-amortizing over a longer period than the remainder of the period on your current loan. |
| Typically, but not always, increases your payment |
Generally reduces your monthly payment |
What can cash out money be used for?
During the loan application you identify the purpose of the money that you are going to get. A cash out refinance generally means that you intend to walk away from the closing table with a check in your hand, yours to do with whatever you please. You can use it to pay for a vacation, buy a boat, pay for college, invest, or anything else that you see fit. There is typically no restriction on what the money can be used for.
What are the benefits of a cash out refinance?
Other than the obvious one of walking away from the table with a check you mean? Remember this. If you sold your primary residence to get your equity out of it, and you have owned the home for less than two years, you will pay tax on your capital gains (with some exceptions). Meaning that if you sold the house for more than you paid for it, you will be taxed on the profits.
The Federal Taxpayer Relief Act of 1997 says that when you sell your home, and have lived in it for two years or more as your primary residence, you will not be taxed if your gain is $250,000 or less if you are single, or spouses filing seperately, and your gain is tax free up to $500,000 if you are filing jointly. (Please remember to get a financial tax consultant to help you make a financial decision). On the other hand, if you did a cash out refinance in the first two years your funds will not be taxed since it is not capital gains, but loan proceeds. Don't forget that should you sell, your gains will become capital gains if you sell before you owned the home two years (with exceptions of course)
What do I need to know that will hurt me if I didn't?
Mortgage rates are based on many things, one of which is the percentage of the loan compared to the value of the home. For example, all else being equal, if you borrow 90% of what your home is worth, your mortgage rate will generally be higher than if you borrowed only 75%. Additionally, if you borrow more than 80% and keep a single loan, you will have to pay Private Mortgage Insurance (PMI). To avoid PMI, you can have lender paid MI, meaning that the cost of the insurance is included in the rate, or you can have an 80% first mortgage, and a second mortgage for the remainder.
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