How to Evaluate Cash-Out Refinancing

Some consumers take advantage of the equity in their home by completing a cash-out refinance transaction. This is the process where you refinance your first mortgage and you receive a new mortgage balance which is larger than the original loan. The extra cash you receive can be used for a number of purposes including home improvements, tuition, consolidation, or even for the payment of medical bills.

Equity/LTV

When you complete a cash-out refinance the amount of money you receive is based on the equity in your home. If your home is valued at $100,000 and your balance is $75,000 the amount of equity available is $25,000, which is the difference between the value and balance owed. Some lenders will not allow you to tap into all of the equity, but instead they will allow you to receive a portion of the home value such as 75 or 80 percent of the property value. This is known as your loan-to-value, (LTV).

Interest Rate

Receiving good terms is always a good idea when you complete a cash-out-refinancing transaction. Most individuals are looking for a lower rate of interest. As a rule of thumb if the new rate is lower by two basis points then it is a good idea to refinance. A lower rate of interest will save you thousands of dollars in finance charges during the life of the loan.

Closing Costs

If you decide that a cash-out-refinance is best for you make sure you find out about the closing costs. In general lenders will allow you to roll over the costs into the total amount of the loan which keeps your out-of-pocket expenses down to a minimum. Some of the costs you incur could be for a credit report, title insurance, appraisal fee, and closing costs. The amount of time you plan on staying in your home should be a determining factor as to whether or not you refinance. If you are going to only stay in your home for one year it may not be worth your while to refinance. For example if your costs are $3,500 and your old mortgage payment is $1,000 and the new mortgage payment is $900, as a result of receiving a lower rate of interest you will need to stay in your home for 35 months after refinancing if you want to recover your expenses. You take the difference between the old and new payment and divide that figure into the costs, ($3,500/$100 = 35).

source: http://www.bankrate.com/gookeyword/news/loan/20010824a.asp