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Using A Cash-Out Refinance As A Financial Tool

6-Minute Read
Published on March 20, 2020
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Since the rise of COVID-19, many of us have been scrambling to figure out how to carry on in the face of these unprecedented times. The health and safety of those around us continues to be our primary concern. However, as we adjust to this new reality, we cannot ignore the financial ramifications that it has had on millions of Americans. Many now find themselves out of work and confronted with bills they don’t know how they will pay.

For many of us, the majority of our wealth is tied up in our home. But keep in mind that as we’ve made our monthly mortgage payments, we’ve built equity in our home. Depending on your circumstances, now may be the time to take advantage of that equity. You can use a cash-out refinance as a financial tool to confront unforeseen circumstances, build up your emergency savings, contribute to a retirement or college fund or invest in the stock market or real estate. Let’s take a closer look at how you can use a cash-out refinance to help you regain control during a period of such uncertainty.

Expect The Unexpected

There’s no way around it, unforeseen circumstances can and do arise. You may hit a pothole and have to replace a flat tire, come down with a sudden illness and need to pay medical bills or even be faced with an unprecedented global situation that forces you to rearrange your finances. These days, it’s important to expect the unexpected because they can put a considerable strain on your financial wellness. While it may seem impossible to be fully prepared, knowing your options is a critical step in the right direction.

If you’ve built interest in your home, you can free up funds to make sure that you’re covered. Now that the Fed has lowered short-term interest rates, mortgage rates are also lower. So, choosing to obtain a cash-out refinance can allow you to accomplish two things: You can replace your current mortgage with a new loan at a lower rate, and convert your current equity into cash. If you’re concerned about what the future will bring, a cash-out refinance can help you spring into action and create a new budget.

Emergency Fund

Regardless of your current circumstances, you should take a look at your savings. As crucial as it is to be financially prepared for the unexpected, you may find that you don’t have enough funds set aside in case of emergencies. After all, it’s difficult to build up an emergency fund when you’re bogged down by day-to-day expenses.

If this is the case for you, you’re not alone. According to a 2018 employee financial wellness survey from PwC, 41% of baby boomers, 48% of millennials and 51% of Gen Xers believe they don’t have enough emergency savings to cover unexpected expenses. This concern was shared by 52% of women and 42% of men.

Experts recommend having at least 3 – 6 months of daily living expenses available, but most Americans would have to rely on the funds from credit cards with high interest charges or personal loans to make ends meet. Instead of adding to your piles of bills, a cash-out refinance can enable you to access a major source of untapped capital that you can use to build your financial cushion.

Building Retirement Funds

Retirement is another major concern for many individuals. According to the PwC study, 43% of baby boomers have $100,000 or less saved for retirement. Moreover, 27% of employees aren’t saving for retirement at all, and 42% of employees are retiring later than they previously planned.

Top retirement concerns include running out of money and being unprepared to cover health care costs. Among baby boomers, the group who will be retiring next, only 45% of them even know how much they’ll need in retirement.

As of 2019, the IRS allows you to contribute up to $19,000 per year to your 401(k). If you’re over 50, you’re allowed to contribute anywhere between $1,000 – $6,000 per year if your plan allows for catch-up contributions. The exact limit for these contributions is based on the type of retirement plan you have. If you’re unsure, refer to your documentation or check with your plan administrator.

If you’re behind in building retirement funds, taking cash out of your home could be an excellent way to shore up your nest egg. It would also happen faster than if you were trying to figure out where to cut money out of a tight budget.

College Fund

It’s no secret that the cost of college continues to go up year after year. Yet for many fields, a college degree is considered a prerequisite for getting your foot in the door. Many people may feel like they want to help their children or grandchildren bear the burden of a college education.

If you’re looking to give a boost to a college fund, one great way to do it is to take cash out of your home because it’s your most valuable asset. Taking out a little bit of equity can mean an infusion of thousands of dollars in your investment in someone’s future.

Making Investments

The stock market has taken a serious blow recently. While it’s uncertain whether we’ve hit bottom yet, individuals looking to make long-term investments may find that now is a good time to enter the market. Typically, if you invest in a broad range of stocks over time – an index fund, for example – research has shown you can make a return of about 7% after inflation. This statistic is based on the assumption that you’re going to buy and hold on to the stock for a long time before selling.

With rates in the mid- to high 3% range for a 30-year fixed mortgage, you can find yourself making more money in the stock market if you take cash out. In the long run, if you make investments, you’re more likely to receive a higher return than if you were to put the money into a savings account. If you’re unsure about any particular investment strategy, consult a financial advisor.

Investing In Real Estate

If you’re comfortable becoming a landlord, taking cash out to make a down payment on a rental property could represent a good opportunity to gain passive income.

When evaluating investment property opportunities, one of the important things to look at is capitalization rate. Cap rate is a measure that looks at the percentage of the overall value of the property that you could collect each year in rent after factoring in expenses. For this, you need to know both the value of the property and what you could reasonably expect to charge for a similar property in the area. The higher the cap rate, the better.

In addition to the rental income, you also have the benefits that come from having a house in general. With each monthly payment, you gain equity, and you can use that value to turn into cash for other things down the line. If the property gains value between the purchase and the sale, you also make money on the sale. Home values also typically outpace inflation, sometimes by several percentage points. Although price appreciation has been slowing down, market values have been consistently going up.

Moreover, a market that’s slowing down may actually be beneficial if you’re looking to buy an investment property. Everybody wants to try to get a deal.

The distinct advantage of taking cash out is that it can help considerably with the affordability of a down payment. The minimum down payment on a one-unit investment property with a median FICO®Score of 720 or higher is 15%. If you have a slightly lower credit score or would like to purchase a property with 2 – 4 units, you’ll need a higher down payment of up to 25%.

Check out this post for more information on the investment potential of rental properties.

Cash-out refinances can be a powerful financial tool. If you’re interested in looking at your options, you can get started online or give us a call at (888) 980-6716.

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