Cash-out mortgage refinance explained

Cash-out mortgage refinance is basically mortgage refinance. With cash-out mortgage refinance, you take out a new home loan that is more than enough to pay off your current mortgage, leaving some cash for you to pocket.

Here's an example: Let's say you still owe $100,000 on a $130,000 house, and you want a lower interest rate. You also want $20,000 cash, maybe to spend on your child's educaction at Yale. You can refinance the mortgage for $120,000. That way, you get a better rate on the $100,000 that you owe on your existing home loan, and you get a check for $20,000 to spend as you wish.

a cash-out mortgage refinance differs from a home equity loan in several ways:

1. A home equity loan is a second home loan. It is a separate home loan on top of your first mortgage; a cash-out mortgage refinance is a replacement of your first mortgage.

2. The interest rate on a cash-out mortgage refinance is usually, but not always, lower than the interest rate on a home equity loan.

3. You have to pay closing costs when you refinance your first mortgage; you don't have to pay closing costs for a home equity loan. Closing costs can amount to hundreds or thousands of dollars.

With cash-out mortgage refinance, you increase your loan amount that includes your current mortgage and the cash you want. Hence it doesn't make sense to take out the cash-out mortgage refinance (ie the higher loan amount) at a higher rate. If your current mortgage is at a lower interest rate than you could get now by refinancing, it's probably better to obtain a home equity loan as a second mortgage to get the cash you want instead, and leave your current mortgage alone.

Note that if your cash-out mortgage refinance is more than 80% of the market value of your home, you will be hit with private mortgage insurance (PMI), costing you hundreds a year. In our above example, the house is purchased probably not long ago, because the current outstanding mortgage is still a high $100,000 vis-a-vis the cost of $130,000. The current market value of the home will probably not be significantly higher than $130,000. The cash-out mortgage refinance amount of $120,000 in the example will probably exceed 80% of the home's market value, and hence will attact private mortgage insurance.