If you've built up equity in your home and you want to take some out to pay for a new roof or a new sports car, you'll want to get what the industry calls a cash-out mortgage. Unlike a home-equity loan, where you borrow against the equity, a cash-out mortgage is a completely new loan for the amount you still owe on the original mortgage, plus the cash you'd like to spend now.
Contact your lender or mortgage broker and let them know you want to refinance with cash out. A mortgage broker can find you a low interest rate and possibly a no-fee mortgage, though not necessarily with your current lender.
Fill out the mortgage application. State how much you owe on the home and how much you want to borrow.
Submit the application along with other necessary documents, including proof of income, tax returns, or other financial data required by the lender. Remember, you're applying for a brand new mortgage, so you have to go through the same hoops you did the first time around.
Prepare your home for an appraisal. Refinancing requires a new valuation on your home, so the bank can be sure it's worth the total amount you want to borrow now, including the current principal plus cash-out amount. The bank will put its appraiser in touch with you. Point out any repairs or improvements you've made on the property since the last appraisal, which will maximize the valuation.
Wait for the mortgage approval. Your loan officer or broker will tell you how long a decision will take. You'll have to pay new closing costs in most cases, unless your financial institution waives them. Your loan officer will discuss options for receiving the cash payout.
- Using a mortgage broker can save some headaches with paperwork. The broker will keep you apprised of the status of your application, handle paying off the old mortgage and send you a check for the cash-out portion once the new mortgage is funded.
- Refinancing an older mortgage means you'll be building up equity more slowly, since new payments will go primarily toward interest and not principal. If you've been paying on your home for more than 10 years, a home-equity loan might make more financial sense. Older mortgages might have prepayment penalties, so include that in your cost of refinancing.
- Refinancing requires paying for a home appraisal and closing costs, which can run in the thousands of dollars. Home-equity loans require neither of these up-front costs. So even with higher interest rates, home-equity loans might work out cheaper. Do the math before deciding.
- Only the interest paid on what the IRS calls "home acquisition debt" or home equity debt is tax deductible. That means if you finance more than the fair value of your home and use the money other than for home improvements, you can't take a deduction for the interest on the portion of your new mortgage which exceeds its fair market value.
- If you refinance for more than 80 percent of the value of your home, be prepared to pay private mortgage insurance until you get the principal below that threshold. At about 1 percent of the mortgage amount, it can add up to a hefty extra payment each month and make a home-equity loan look more attractive.
Naomi Smith has been writing full-time since 2009, following a career in finance. Her fiction has been published by Loose Id and Dreamspinner Press, among others. She holds a Master of Science in financial economics from the London School of Economics and a Bachelor of Arts in political economy from the University of California, Berkeley.