Refinancing Your Home and Taking Out Equity
Refinancing your home and turning some of the equity in your home into cash is a logical way to ease your current debt load. Refinancing is simply financing your mortgage again in an attempt to decrease your monthly payments, the interest rate of your mortgage, the length of your loan, or all three.
Suppose your house is worth $170,000, you financed $153,000, and you currently owe $120,000. Your equity is $50,000. If you refinance without touching the equity, your new loan will be for $120,000, which will make your payments lower than when you bought the house. And if interest rates are lower than when you first obtained your mortgage, your payments will be lower still.
You can then decide whether you want to decrease the length of your loan (say, from 30 years to 15) while keeping the same monthly payment as before, or whether you want to keep the length of the loan the same and have a lower debt obligation every month.
You can, however, also use some of the equity in your house to pay off other debts. Refinancing and removing equity at the same time amounts to getting a new loan for a higher amount than you currently owe on your home.
Instead of refinancing your home for $120,000, you can receive cash for some portion of your equity — perhaps $15,000 — and refinance for $135,000 ($120,000 owed on your mortgage plus $15,000 cash).
Not all of the equity in your home will be available for you to cash in. Some lenders require you to keep 20 to 25 percent of your home's value as an ongoing down payment. Other lenders don't allow you to use the current value of your home, and instead use the original purchase price to determine your equity.
Do You Have Enough Equity?
If you bought your house with a 3-percent down payment on a 30-year loan four years ago, and your house hasn't increased much in value, you may not have enough equity to tap. Thirty-year loans are notorious for building equity very slowly.
In fact, if you finance $100,000 on a 30-year loan at 7 percent with $5,000 down, you'll have paid just $4,400 of your $100,000 mortgage after four years, and only $13,600 after 10 years. On an identical loan for 15 years, though, you'll have chewed up almost $17,000 of your mortgage after four years, and nearly $53,000 after 10 years.
Before applying for a refinance with cash back, make sure you have enough equity. Keep in mind, however, that when interest rates are lower than they were for your original loan, you should still consider refinancing without cashing out any of your equity, either to lower your monthly payments and relieve some of your monthly debt or to reduce your mortgage to 15 years, allowing you more options for saving for retirement or your child's college education.
Do You Have a Solid Retirement Plan?
This may seem like an odd question in a section about tapping your home's equity. If your retirement years are well provided for, either by your company's retirement plan or by investments you've made, lowering the equity in your house by refinancing and getting cash back is a fine idea. But if your retirement savings is shaky or nonexistent, keep the equity in your house and refinance for the fewest number of years possible.
You can sell your large home and move to a smaller one when you retire, paying cash for the smaller home and putting the difference into your retirement fund. This is one way to save for your retirement.
If you refinance your home for 15 years when you're 40 years old, you'll own your home free and clear when you're 55. You'll realize two benefits: You can spend the 10 years from 55 to 65 putting the amount of your previous house payment into retirement savings and you won't have house payments when you retire, which means you'll need less retirement income.
