Cashing Out Refi: Smart Investment Or Risky Move?

Cash-out refinancing is a way to access cash by replacing your current mortgage with a new, larger loan. This can be a good idea if you have sufficient retirement and emergency funds and the rate of return on your investment will be higher than the interest rate on the cash-out funds. However, it is important to note that cash-out refinancing increases your loan balance and monthly payments and there is a risk of losing your home if you can't make the payments.

Using cash-out refinancing to fund a home improvement project

For example, adding a master bedroom suite to your home could cost $100,000 or more, while remodeling a kitchen could run $60,000 or more, and remodeling a bathroom may cost $50,000 or more. These projects also add to the value of your home, meaning you're enhancing your real estate investment and not just spending money.

However, it's important to note that cash-out refinancing increases your loan balance and monthly payment since you're withdrawing your home's equity to access cash at the loan's closing. It's also important to evaluate the pros and cons and weigh the benefits of converting equity into cash with the risks associated with taking out a new mortgage loan.

One of the risks of cash-out refinancing is that it increases your total mortgage repayment costs and you could end up owing more than your home is worth. It's also important to have sufficient funds to cover the closing costs, which can range from 2% to 6% of the loan amount.

Paying off high-interest credit card debt

High-interest credit card debt can be a burden, but there are ways to manage it. One option is to use a cash-out refinance, which involves taking out a new mortgage on your home for a larger amount than you currently owe and receiving the difference in cash. This cash can then be used to pay off your credit card debt, leaving you with a single, more manageable payment at a lower interest rate.

However, there are some considerations to keep in mind. Your monthly mortgage payments will increase with a new, larger loan, and you will be committing to a new loan and repayment structure for a longer term. There are also closing costs associated with a cash-out refinance, typically ranging from 2% to 6% of the loan amount, which can impact the overall savings of consolidating your debt.

Another option for paying off high-interest credit card debt is to use a debt consolidation loan, which is a personal loan that combines and pays off other high-interest balances. This option does not require you to have home equity, and your home is not at risk if you default. You could also consider a balance transfer credit card, which offers an introductory 0% APR, allowing you to eliminate debt interest-free if you pay it off before the promotional period ends. Additionally, you can try negotiating a lower interest rate with your credit card company, especially if you have good credit and a positive payment history.

Before deciding on a cash-out refinance or any other debt repayment strategy, it is important to evaluate your financial situation and goals, as well as the potential risks and benefits of each option.

Adding to or protecting your existing investments

When considering a cash-out refinance, one key motivation is the potential to grow or safeguard your existing investments. Here's a detailed look at how a cash-out refi can help you achieve these goals:

Adding to Your Investments:

A cash-out refinance can provide a substantial sum of money that can be used to bolster your investment portfolio. This strategy is particularly attractive when you have identified a potentially lucrative investment opportunity that requires a significant capital outlay. By tapping into the equity in your home, you can access funds that may otherwise be challenging to obtain. For example, let's say you're an experienced investor with a diverse portfolio, and you wish to purchase a rental property. A cash-out refi can provide the necessary funds for a down payment on the rental property, allowing you to expand your real estate investments.

Diversifying Your Investments:

Using the funds from a cash-out refinance can also help diversify your investment portfolio. If you have a concentrated position in a particular stock or asset class, you can use the cash to invest in other sectors or asset types, thus reducing your overall investment risk. For instance, you could invest in a range of mutual funds or explore alternative investments like real estate investment trusts (REITs) or even tangible assets like precious metals or collectibles. Diversification can help protect your portfolio from market volatility and ensure your investments are more resilient in various economic conditions.

Protecting Your Investments:

In some cases, a cash-out refinance can be a strategic move to safeguard your existing investments. For example, if you have investments tied up in volatile assets or businesses with significant cash flow requirements, a cash-out refi can provide a cushion to protect those investments. The funds can be used to cover any short-term cash flow gaps or provide liquidity to weather market downturns. Additionally, if you have investments with high-interest debt attached, such as margin loans or credit lines, refinancing your mortgage at a lower interest rate could be a way to reduce the overall cost of servicing that debt.

Retirement Planning:

Another aspect of protecting your investments is ensuring you have sufficient funds for retirement. A cash-out refinance can provide a substantial sum to bolster your retirement savings. This is especially beneficial if you are self-employed or work in an industry without a traditional pension plan. The funds can be used to maximize contributions to tax-advantaged retirement accounts, such as a 401(k) or IRA, or even to fund a self-directed retirement plan. By doing so, you not only protect your current standard of living but also ensure your investments continue to work for you well into the future.

It's important to remember that a cash-out refinance is not suitable for everyone and should be approached with caution. Careful consideration of your financial situation, investment goals, and risk tolerance is essential. Consulting with a financial advisor can help you make an informed decision about whether a cash-out refinance aligns with your investment strategy and long-term financial objectives.

Buying an investment property

There are two main types of investment property: residential and commercial. Residential properties are the most common type of investment property and include single-family homes, condominiums, and apartments. Commercial properties include retail, office, and industrial spaces.

When buying an investment property, it is important to consider cash flow and risk tolerance. You need to ensure that the property will generate enough rental income to cover the monthly mortgage and other expenses, such as insurance, property taxes, and maintenance. It is also crucial to have enough disposable income to cover any unexpected expenses or vacancies.

• Obtain mortgage pre-approval: Work with a lender to get pre-approved for a mortgage and understand your budget.
• Crunch the numbers: Calculate the potential rental income and expenses to determine if the property will generate positive cash flow.
• Consider all the costs: Don't overlook costs such as insurance, property taxes, maintenance, and periodic major expenses.
• Scrutinize tenant quality: Perform background checks on potential tenants to reduce the risk of losses.
• Understand your legal obligations: Familiarize yourself with the legal rights of tenants, such as the right to fair housing and habitable living conditions.

Remember that investing in an investment property requires careful planning and preparation. Assess your financial stability, the property's potential to turn a profit, and the time commitment required to manage the property.

Buying a second home

A second home can be a great investment and a way to generate passive income. It can also help you prepare for an early retirement. However, it's important to carefully plan and consider all the associated costs, as well as the time and energy required to maintain a second home.

The median US home price is $389,500. However, there are additional costs to consider when purchasing a second home, including homeowners insurance, property maintenance, HOA fees, furnishings, and property management services. It's also important to remember that a second home will require a significant time investment, especially if you plan to rent it out.

Most people invest in second homes for one of three reasons: as a personal vacation asset to hold for later resale, as a short-term rental property, or as a long-term rental property. Each option has its own pros and cons, and it's important to understand the differences before investing.

Personal Vacation Asset for Later Resale

This option allows you to enjoy your second home whenever you want and may be easier to finance than a rental property. However, it provides no active income streams and may require higher insurance rates since it's not a primary residence.

Short-Term Rental

Renting out a second home to short-term tenants has grown in popularity. This option can generate an income stream to help offset mortgage and maintenance costs, but it requires upfront furnishing and decorating costs. It also means frequent maintenance and cleaning, and you'll need to maintain an active listing on a short-term rental site.

Long-Term Rental

Long-term rentals provide a more consistent income stream with less work than a short-term rental. However, they may not be as lucrative and can put more wear and tear on the house.

Mortgage and Tax Differences

When considering a mortgage for an investment property, you can expect higher interest rates, down payments, and credit score requirements compared to primary and second homes. Lenders will also have specific requirements for how often you must occupy the residence and when you can rent it out to tenants.

For tax purposes, a second home must be occupied by the owner for at least 14 days per year and cannot be used as a rental property for more than 180 days per year. An investment property, on the other hand, is used by the owner for fewer than 14 days per year and can be rented out for any period.

Will You Get a Good Return on Your Investment?

To determine if a second home is a smart investment, you should research the average rent occupancy rates and real estate appreciation in the area you're considering. Factor in all the associated costs, including maintenance, mortgage payments, and property management. If you're aiming for future resale, create a timeline and budget for property improvements to increase the home's resale value.

Alternative: Co-Ownership

If buying a second home sounds like too much of a hassle or financial burden, consider co-ownership. With co-ownership, you can own a share of a turnkey, fully managed vacation home and enjoy it several times a year while saving on the total cost of ownership.

Steps to Buying a Second Home

• Decide where to buy: Choose a location you love and discuss it with your family.
• Determine how to finance the purchase: Consider your financing options, such as conventional or jumbo loans. Keep in mind that government-backed loans like VA and FHA loans cannot be used to purchase second homes.
• Get pre-approved for a second home mortgage: Starting the mortgage process early will help you identify any financial obstacles and give you a better idea of your budget.
• Partner with a local real estate agent: A local agent will have a better understanding of the market and can offer valuable advice.
• Find your dream second home: Work with your agent to find a home that fits your criteria and budget.
• Close on your second home: This process typically takes 30-40 days and includes choosing an attorney or closing agent, buying insurance, buying title insurance, scheduling a home inspection, arranging an appraisal, and doing a final walk-through.

Final Thoughts

Frequently asked questions