3 Bad Reasons to Do a Cash-Out Refinance
by Maurie Backman | Updated July 19, 2021 - First published on June 21, 2021
If you're going to take money out of your home, make sure it's for the right purpose.
Mortgage refinance rates are very low these days, so a lot of borrowers are getting new home loans to take advantage of them. Now, when it comes to refinancing, you have choices. You could do a standard refinance where you borrow your exact mortgage amount, or you could do a cash-out refinance where you borrow more than what you owe on your home and then use the extra money for whatever purpose you'd like.
In some situations, a cash-out refinance can be a smart move. But here are three bad reasons to get one.
1. To take a vacation
After the year we've all had grappling with the pandemic, we could all use a getaway -- maybe even an extended one. But borrowing money to take a vacation isn't usually a financially sound move.
Remember, a cash-out refinance is still a loan. When you do one, you wind up with a larger mortgage balance than what you started with, and while you may manage to snag an affordable interest rate on your new mortgage, it's debt nonetheless. A better bet is to take a low-key vacation now if that's all you can swing, and then work on saving up enough money to take a longer, more extravagant one down the line.
2. To maintain a lifestyle you can't afford
If you've been falling behind on your bills for quite some time, you may be tempted to do a cash-out refinance. That way, you could use the extra money to supplement your income and keep up with your bills.
But actually, that's not a great idea. If you consistently can't cover your living expenses, it means you're spending too much. And if so, your best bet is to set up a budget so you can track your spending and start cutting back in areas where you have the most wiggle room.
3. To pay off a very small credit card balance
If you have a large amount of credit card debt in your name, then a cash-out refinance could be a good way to pay it off. Imagine you owe money on a credit card charging 22% interest, and you can refinance your mortgage at 3.2%. If you take the proceeds from your cash-out refinance and use that money to pay off your credit card debt, you'll save yourself a lot of money on interest, so doing that makes sense when your credit card balance is substantial.
But if you only owe, say, a few hundred dollars on a credit card, then a cash-out refinance may not be as cost-effective as you'd think. That's because you'll pay closing costs on the amount you borrow that could easily end up equaling 5% of your loan. If your credit card debt is minimal, you may be better off seeking out a balance transfer credit card offer instead.
A cash-out refinance could help you consolidate large debt, make improvements to your home, or pay for expensive repairs you've been putting off. But don't do a cash-out refinance if your goal is to spend money on something you can't afford, maintain a lifestyle you can't really swing, or pay off a minimal amount of debt. There are better ways to address those issues, and if you do a cash-out refinance in any of those situations, you might end up regretting it.
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