If you want to get access to some cash for an upcoming major expense, you might be able to avoid the high interest loans and look to your mortgage instead. Keep reading to find out what a cash out refinance is and whether it’s a good move for you.
A cash out refinance is when a homeowner refinances their existing mortgage to access the equity they’ve built up in their home, in the form of cash.
These extra funds can be released into an offset account, bank account or as a line of credit. It can be a good alternative to taking out additional loans but will ultimately delay the time it takes to pay off your mortgage.
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Home equity is the portion of your home’s value that you own outright. You can calculate your equity by figuring out the difference between your property’s current value and the remaining loan balance.
In order to accurately calculate your home’s equity, you’ll need to know it’s up to date value. So, you may need to conduct a formal property valuation. You can organise this yourself, or your lender may do this during refinancing.
Here’s an example of home equity:
If your home is valued at $800,000 and you have a remaining loan balance of $200,000, your equity will be $600,000 (75%).
Your equity will increase if your property’s value increases since the date you purchased it. There are a number of ways you can increase your property’s value:
The overall process of a cash out refinance is similar to any other home loan refinance. Here are the general steps:
Read more about the refinancing process here.
Since everyone’s home loan, property and financial circumstances are different, the amount of cash you’ll be able to get out will vary. Ultimately, it will depend on the amount of equity you have in your home. So, if you have a large amount of equity due to paying down your mortgage and/or your property’s value increasing, you’ll have more cash to access.
Lenders will generally allow you to borrow up to 80% of your property’s value, so if your Loan to Value Ratio (LVR) is higher than 80%, you may not be able to get cash out. Some lenders may allow you to do a cash out refinance if your equity is under 20% by charging Lenders Mortgage Insurance (LMI).
Lenders often place restrictions on cash out refinances to protect their interests, as well as to protect borrowers from making poor financial decisions. Particularly for borrowers with lower equity, banks will want to see evidence that cash taken out is used for the intended purpose.
If eligible, using your equity to fund home improvements can be a great option. Unlike credit cards and personal loans, you won’t be subject to sky-high interest rates.
One thing to be aware of is that not all ‘renovations’ can be funded through a cash out refinance. If you are making structural changes, knocking out walls or building a granny flat, for example, this can be covered under a construction loan, rather than a cash out refinance.
You may also be able to use cash to fund a holiday or car purchase, for example.
One potential use for cashing out your equity is getting the funds you need for an investment property deposit.
Property investment isn’t the only investment option out there. Investing in shares, for example, is another reason to consider getting a cash out refinance.
You may wish to use cash from your equity to pay off other higher interest loans or credit cards. Alternatively, you could consolidate these unsecured debts under your home loan where they’ll benefit from a lower interest rate.
Roll your credit card, car or personal loans into your home loan.
When you access equity from your home the amount you owe on your home loan will increase. As a result your repayments will likely increase and you’ll need to budget for this change.
Some of the reasons people access cash can lead them into bad financial situations. For example, paying off a credit card (unsecured debt) with a secured debt. If you get into the habit of doing this, you risk becoming comfortable increasing credit card debt in the future and relying on your home loan to pay it off.
Your mortgage isn’t a vending machine where you can punch a few buttons and expect lavish holidays and purchases to fall out. It won’t always be able to get you out of sticky situations or fund your desired purchases.
An unfortunate reality of cash out refinancing is understanding that your home loan debt will be increased and in turn, your loan repayments. You may have to increase your loan repayment term in order to comfortably pay off the balance.
Remember that if you increase your loan repayment term, you will pay more interest over time.
If your home loan is currently on a fixed interest rate, you can expect break fees to come with your cash out refinance. Lenders charge break fees here because you are opting to refinance your home loan before the end of your fixed period.
Before refinancing your fixed rate home loan, find out how much the break fee will be and whether refinancing could still be worthwhile. If you’re questioning whether a cash out refinance is a good move for you, consider speaking to a financial advisor or a mortgage broker.
The duration of a cash out refinance will usually be similar to any other refinance, it can often take 2-4 weeks, depending on the lender’s processing times, your circumstances and how quickly all required documents are submitted.
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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.
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