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Is Cash-Out Refinancing Right for You
BDG
John wants to borrow $30,000 from the equity he has in his home to make home improvements. Mortgage rates have dropped 4% since John took out his mortgage and he has $100,000 left on his mortgage. Should John get a home equity loan or should he refinance his first mortgage and use a 'cash-out' option to get the money he needs for his home improvements.
Analysis
Even if John did not want any money for home improvements, he should most likely refinance his first mortgage. As a rule of thumb, if mortgage rates have dropped two 2% or more since you have taken out your mortgage, it most often makes sense to refinance your mortgage. Factors that may not allow refinancing to be a viable option include: 1) a pre-payment penalty on your mortgage, 2) a small amount left on your mortgage which may not result in enough benefit to offset refinancing costs.
Since rates have come down sharply since John took out his first mortgage and he still has a sizable mortgage to pay off, John should refinance his mortgage. If he also wants to borrow from the equity he has in his home, cash-out refinancing is a sensible option.
If John was to 'cash-out refinance', John would take out a new mortgage for $130,000. He would pay off his current mortgage of $100,000 and the $30,000 that he has left over would be the equivalent of a home equity loan. John would therefore lower his mortgage rate and the $30,000 he has borrowed from his home's equity would also likely be at lower rate than if he were to take out a separate home equity loan.
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