Cash-out refinancing

Equity in a home can be a useful investment tool for the average home owner as it may be the equivalent of having a savings account that accumulates interest at a rate of five percent per year. That rate is based on the average historical increase in home values in most major markets across the country, barring bubbles. On the other hand, money in a savings account that pays one percent per year (if your bank is generous) is just barely more productive than lying under your mattress. So if equity in your home is so productive, why would anyone want to pull it out?

Why take out cash?

There are several reasons home owners take cash out of their home by refinancing:

Paying off debt

Some home owners struggle under the burden of paying hundreds of dollars per month toward credit card debt. Quite often, they are just able to make the minimum payment as there are too many demands on a limited budget. It’s possible to continue this way for many years without appreciably lowering the balance owed on one, two or even three credit cards. It makes sense to put the equity in their home to work and free up cash flow that can be used to replace the equity you used in the first place.

Let’s say you have an appreciable amount of equity in your home but you owe $20,000 in credit card bills. You could be looking at a monthly minimum payment of $600. Let’s say you have a car note of $400 on a modestly-optioned mid-size sedan, your total outlay on debt payments could begin to approach the size of your mortgage payment. Were you to refinance your home, taking cash out to pay off the car note and credit cards, your mortgage payment may not increase by much, especially if you had a high rate note, but you now have $1,000 in hand EACH MONTH, that you never had before refinancing.

But my equity is gone, you say

Not so fast. Let’s say your home is valued at $200,000 and you took $40,000 cash out to pay off debt. At the average rate of home price appreciation (as per the census bureau and National Association of Realtors) you would recover your equity in less than five years. But don’t forget you now have $1,000 in free cash flow having paid off your debts. Adding half of that to your principal payment will reduce the length of time it will take you to pay off the new loan.

Home improvement projects

Using the equity in your home to effect needed repairs or to upgrade the home can enhance the long-term value of your property. If you plan to stay in the ouse for the long run and need to remodel or add a new room or expensive heating and air equipment, it may benefit you to refinance.

Cash-out for an investment

Another popular use of cash-out refinancing is for investment purposes. Home owners with large amounts of equity in their homes often seek new income streams through investing in rental units or vacation homes with down payments drawn from the equity in their primary residence. As with paying off credit card debt, appreciation in the value of your primary residence may replace the equity used in as little as five years. If you are using the cash from a refinance to buy investment property, you may also realize equity gains from the second property as well.

The bottom line

Put to careful use, the equity locked up in your home could be a huge benefit. You may be able to increase your cash flow by paying off high interest debt or by acquiring net rental income from an investment property. A home improvement project may add value to your property and if you reside in an area where values are growing at, or above, the national average, you should be able to recover your equity in a few years.

photo courtesy of Ali Bakhtian, modified from the original 5556x4169 to 640x360.