3 Mistakes You Might Make if You Do a Cash-Out Refinance in 2023

Generally speaking, now's not really a good time to refinance a mortgage. That's because mortgage rates are relatively high, so chances are, you won't reap savings by swapping your existing home loan for a new one.

But if you want to tap your home equity and take cash out of your home, a special type of refinance called a cash-out refinance could make sense. When you do a cash-out refinance, you borrow more than your remaining mortgage loan balance. 

Let's say you owe $170,000 on your current mortgage and need $30,000 to pay for a renovation. You could do a $200,000 cash-out refinance in that situation, use the first $170,000 to satisfy your existing loan balance, and then spend the remaining $30,000 on the project you have in mind.

An estimated 42% of mortgages that were refinanced in 2021 were of the cash-out variety, reports Freddie Mac. Of course, back then, borrowing rates were lower, so mortgage refinances made more sense. But you may find that a cash-out refinance is actually your cheapest option for borrowing money this year. And if that's the case, you may decide to go for it.

But if you're going to do a cash-out refinance, make sure to avoid these major mistakes. Otherwise, you might sorely regret your decision.

1. Not working to boost your credit score before applying

You might assume that since mortgage rates are generally higher these days than they were a couple of years ago, it really doesn't matter what your credit score looks like -- you're probably doomed to a higher borrowing rate no matter what. That may be true to some degree. But it still pays to try your best to raise your credit score before moving forward with your refinance. A higher score might result in a lower refinance rate than what a borrower with a less favorable credit score might get -- even if that rate isn't one you'd necessarily consider a bargain.

Once your credit score gets into the upper 700s, you're generally in line for the most competitive rate any refinance lender will give out. So if your score is a little shy of that, try checking your credit report for errors, because correcting certain mistakes could result in a boost. You can also raise your credit score by paying off a chunk of credit card debt.

2. Not looking into closing costs

Because borrowing rates are up right now, you're generally looking at paying more to refinance your mortgage, whether you do a cash-out refinance or a regular refinance. That's why it's so important to pay attention to closing costs. Just as you're charged a series of fees to put a purchase mortgage into place, so too do various fees apply when you refinance to a new loan. Read up on the fees you're looking at, and if they come off as unreasonably high, ask if any can be negotiated. 

3. Applying before you run the numbers

You may get approved for a cash-out refinance based on the equity you have in your home. But that doesn't mean you can afford to change the monthly payments on your mortgage. So before you submit your application, use an online calculator to get a sense of what your new mortgage payments might be. If they're too high to fit comfortably into your budget, you might really struggle financially once your new home loan is in place.

Even though it's gotten expensive to refinance, it may be a logical move for you this year. Just steer clear of these pitfalls so you don't wind up kicking yourself after the fact.