4 Top Alternatives to the Cash Out Mortgage Refinance

Do you need money for things such as home improvements, consolidating debt or making investments? You might be thinking about a cash out refinance. This means that you refinance your first mortgage with a bigger loan than you need to pay off the old mortgage and take the difference in cash when you close.

Doing a cash out refinance can be a good way to get money that you need, but it can be a poor choice for some people. Below is information about your alternatives and more details about the cash out refinance.

Alternatives to the Cash Out Refinance

If you need cash and do not want to refinance your mortgage, what should you do? Here are your major options:

HELOC

A home equity line of credit is a second mortgage with lower closing costs and more flexibility than a cash out refinance. It also does not take as long to close. You only will pay interest on the amount of credit you use. The funds can be used for any reason, including college tuition or paying off credit cards.

A HELOC will have a low introductory rate for the first months or years and you may only pay interest on the loan at first. The rate can go up later and you will need to pay principal as well. But the rate on a HELOC will be much lower than non-secured debt.

Home Equity Loan

A home equity loan is also a second mortgage that has a fixed interest rate. A major difference from the HELOC is that you take your equity in one lump sum. You will pay interest on the entire amount from the start, whereas with a HELOC you only pay interest on the amount of the credit line you are using.

Refinance First and Take Out a Second

Another option is to refinance your first mortgage to a lower rate if you can, but do not take out cash. Instead, do a HELOC or home equity loan with the lower closing costs and fees. This can be a great choice for lowering your rate and getting you the cash, you need at a lower price.

Personal Loan

If you do not want to use your equity, your last major option is a personal loan. This is an unsecured loan that will have a higher interest rate than a loan on your home. But approvals for this type of loan are faster, and you are not risking your home if you do not pay the mortgage.

Cash Out Refinance Details

One of the disadvantages to doing a cash out refinance is the rate is higher. Fannie Mae, for example, will charge at least .375% more on the entire loan amount for a cash out refinance. Note, this higher rate is not just on the cash out amount; it is on the entire loan amount. That is a big penalty to pay as the interest adds up to big bucks over the years.

If you want a lot of cash, it could make sense because the rates that you will pay for other types of loans will usually be much higher than a mortgage interest rate. But if you owe a lot of money, it is an expensive way to borrow funds.

For example, say that you refinance a $400k mortgage loan and take out $20,000. If you get a higher rate to the tune of 1.875%, the cost is $7875, which is nearly 40% of the money you are getting. In this situation, you would be better off with a personal loan.

Also, a cash out refinance takes a while to get. Underwriting and eligibility for these loans are stricter today than a decade ago and can take months to close. You can expect to need a 660-credit score for many cash out refinances as well.

Taking on more debt on your first mortgage means that you will have a higher payment, and if you do not make the payment, you will lose the home.

Another thing to remember is we are in a rising interest rate market in 2018. If you refinance a home loan that you got in the last five years, odds, are you will be paying a higher rate. Even two years ago, 30-year fixed rate mortgages could be had for less than 4%. Now the typical rate is 4.5% or higher.

The Bottom Line

Many financial experts think that if you want to pull out equity, a second mortgage is usually the best option. The fees and closing costs associated with refinancing your first mortgage are substantial.