One of the beauties of home ownership is that every time you make a monthly payment, a little more of your house actually belongs to you. With every payment, the equity in your home grows. It can even be compared to an interest-bearing savings account. As a potential source of funds, you can exchange a portion of that equity for cash in the form of a home equity loan or a cash-out refinance.

Let’s assume, for instance, that you own a home that has a value of $200,000 and you owe $120,000 on the mortgage loan. You therefore have $80,000 equity in that home. You can gain access to that equity with a cash-out refinance. Cash-out refinancing involves refinancing your existing mortgage for an amount larger than what you currently owe, and keeping the excess cash for yourself. So by refinancing for $160,000, you could pay off the existing mortgage and get $40,000 cash at closing.

If you’ve owned your home for some time, then the principal that you owe is likely to be substantially less than what it was when you first acquired the property. That steady build-up of equity will allow you to refinance for an amount that is above and beyond what you currently owe. So, the proceeds of the new loan would be split between paying off the original mortgage loan and you, the borrower, pocketing the remainder.

Typically, banks will allow only homeowners to refinance up to 80% of their home’s appraised value. That’s why, in the example above, you could only get $40,000 cash back. The $160,000 refinance loan is the full 80% of the value of the property. If you were to borrow more than 80% of the home’s value, the lender would require you to purchase Private Mortgage Insurance (PMI), or pay a higher interest rate. In such instances, a Home Equity Loan or Line of Credit (HELOC) might be a better way to access your equity.

With cash-out refinancing, you have ready access to a substantial amount of capital in one lump sum which can be used for virtually any purpose that you desire. Homeowners frequently utilize cash-out refinancing for a wide variety of major expenditures including debt consolidation, home improvements and renovations, higher education expenses, new vehicle purchases, or vacations.

Refinancing usually makes sense only when you can get a lower interest rate than your current mortgage has and you want to take advantage of the correspondingly lower payments. It can also benefit those who want to lower their monthly payments by refinancing for a longer term than their current loan. In instances where interest rates have risen, a Home Equity Loan or Line of Credit may, again, be a better choice for accessing your equity than a refinance.

Be sure to explore all of your options by using our versatile Mortgage Calculators to determine your costs and savings.

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