Dangers of Cash Out Refinancing

Find out the possible risks of cash out refinancing.

If you’re a homeowner then you are probably aware that you can use your home as collateral to get additional loans. Many homeowners take out home equity loans or home equity lines of credit in order to get more cash. Senior citizens can also use the so-called reverse mortgages. Another option is cash out refinancing.

Cash out refinancing allows a home owner to tap into the equity that they have built up in their home. With cash out refinancing, you can basically add on to your mortgage loan. It differs from a home equity loan in that it is not, like a home equity loan, a second or separate mortgage. Cash out refinancing means you take your existing mortgage loan and replace it with a larger mortgage loan. If the market conditions are right, refinancing may also improve your interest rate.

For example, you may have been making payments on your $300,000 mortgage for years now, and currently have $100,000 outstanding. That’s how much you still owe. With cash-out refinancing, you can get a new loan for $150,000, use $100,000 of that to pay off the old loan, and keep the remaining $50,000 in cash.

The dangers of cash-refinancing are pretty obvious: if your financial discipline is not perfect, you will quickly spend the cash and end up with a larger loan and no additional assets or income to pay it off. Even if you think you can live with bigger interest payments today, you make yourself more  vulnerable to various financial problems such as layoff, emergency medical costs, investment losses, etc.

Be careful about who you talk to about refinancing, if you talk to someone who only cares about making money off of you – chances are they will happily tell you to go ahead with the refinance since they live off the fess you pay for your financial transactions.  Instead, spend an hour of your time honestly evaluating your cash needs and your ability to pay the interest on a larger loan, and then make your own decision about cash-out refinancing. If you feel you don’t know enough about this topic, ask your trusted relatives or friends who have some financial education – at least they won’t try to sell you a loan that will hurt you down the road.