Cash-out refinancing can be a helpful resource if you’re looking to refinance your home and get some liquid cash in the process. But the option can be risky and isn’t right for everyone. Before you plan a cash-out refinance in Texas, let's take a moment to answer some questions you may have about cash-out refinances, including:
- What is a cash-out refinance?
- How do cash-out refinances work?
- What are the advantages and disadvantages of a cash-out refinance?
- Why should you take out a cash-out refinance?
What Is a Cash-Out Refinance?
Like a traditional home refinance, a cash-out refinance replaces your current home mortgage with a new home loan. The big difference, however, is that with a cash-out refinance, the new loan is for more than what you currently owe on the house. The difference between the new mortgage amount and what you previously owed on the home goes into your pocket as cash.
A cash-out refinance in Texas, which also goes by the name Section 50(a)(6) loan, allows this extra cash in hand to be used at your discretion.
How Do Cash-Out Refinances Work?
To start with, you need equity in your home to do a cash-out refinance. In Texas, any homeowner is eligible, as long as you’ve earned 20% equity in the house. Texas laws for Section 50(a)(6) loan also caps the maximum loan-to-value (LTV) ratio that you can obtain for a primary residence at 80%. This means that the biggest mortgage you can receive is 80% of the total value of the property and that you can’t take out 100% of your home’s equity.
Let’s take a look at the math.
Say you have a home whose value is $200,000. You have 40% equity in your home when you decide that you want to secure a cash-out refinance to do some remodeling. The maximum loan that you can take out is $160,000— 80% of the home’s value. You still owe 60% of your house, or $120,000. If you take out the largest loan that you can, cash-out will be $40,000.
Who Can Get the Loan and Who Can Lend?
Recent changes to Texas home equity lending laws have made cash-out refinancing a little more flexible. Primary residences qualify if they are under 10 acres; rural properties up to 100 acres can also be considered. Agricultural homesteads are also eligible.
In addition to this, the number of authorized lenders - lenders that are approved to make this kind of loan - has also grown. Credit unions, mortgage companies, bank subsidiaries, mortgage bankers, and savings and loan associations are now able to lend cash-out refinances.
What Are the Advantages and Disadvantages of a Cash-out Refinance?
Better loan terms and cash on hand to complete a project? It sounds like a win-win. But just like any big financial decision, it’s crucial to weigh the pros and cons carefully before making a decision.
- Mortgage Interest Could Be Tax-Deductible. In some cases, the money you spend on paying off your mortgage’s interest is tax-deductible. If the money borrowed is used to build, buy, or substantially improve your home, you may qualify. You’ll want to double-check if you are eligible for this, though, before banking your decision on the deduction.
- You Can Use the Money to Consolidate Debt. Credit card debt is expensive debt— that is to say that the interest rates are typically higher than other forms of loans or credit. By using the cash from the refinance, you can consolidate your debt and pay it off with a much lower interest rate.
- You Can Use the Money to Consolidate Debt. One draw to refinancing is obtaining financing with a better interest rate or a shorter term than what you have on your current home mortgage.
All of this sounds good, but it’s also important to be aware of some of the pitfalls that come with a cash-out refinance.
- You Could Face Foreclosure. Like any loan that you take out in which you use your home as collateral, there’s a possibility that you could be foreclosure. If you can’t make payments for whatever reason, your home is on the line. Compare this to credit card debt— even though the rates may be higher, the debt is unsecured, meaning an underlying asset does not back it.
- Pay the Cost of Closing. Again. As with any refinance, you’ll have to pay closing costs. In Texas, fees for cash-out refinancing are 2% of the total loan amount (which is down from 3% before 2019). Keep in mind that this doesn’t include other costs associated with refinancing like survey and appraisal costs, title exam reports, title insurance premiums, etc.
Why Should You Take out a Cash-out Refinance?
There’s no set standard to determine when it’s a good idea to do a cash refinance and when it’s not, but some moves are smarter than others.
Smart Money Moves
As mentioned above, it can be extremely beneficial to consolidate and pay off expensive debt. If you’re taking out money to pay off costly credit cards and similar balances, it could potentially save you thousands in the long run, as well as improve other standings like your credit score.
Similarly, using the cash-out to do home remodels can increase your home’s value and give you a higher return should you ever decide to sell.
Beware of Bad Habits
It may be tempting to use the money from a cash-out refinance to take your family on that much-needed vacation or splurge on a new car. But remember— it isn’t free money. You are still paying interest on the amount you borrow, so it’s always best to limit the amount to what you need.
Don’t let your cash-out refinance be a way to enable bad habits. If you use it to pay off expensive debt, don’t fall into the trap of just running up your bills again. As with anything, you’ve got to be smart with your money.
To Sum It Up
For homeowners with more than 20% equity in their home, cash-out refinancing brings the classic advantages of a traditional refinance with the bonus of cash that you can use as you see fit. But like any loan, it’s essential to evaluate your financial situation, consider the advantages and disadvantages, and use your money wisely.