Cash out refinance is a great financial tool when used properly. You can use cash out refinance in a number of ways, such as making improvements to your house for emergency purposes and educational expenses. But you need to be careful when you apply for a cash-out refinance. One of the parameters that you can use to check if a cash-out refinance is a good fit for you is the break-even point.
Let’s take a closer look at cash out refinance and how to calculate the break-out even on the refinance.
What is Cash Out Refinance?
Cash out refinance allows owners to take advantage of the equity they have built on their home over time. The equity can be exchanged for cash, which is given out on a periodic basis instead of as a lump sum. The monetary gains you get from cash out refinance can be used to either consolidate a standing loan with high interest or to renovate the house. When you use the money from the cash-out refinance to improve the condition of your current home, you might be eligible for a tax deduction. Just make sure that you consult your financial supervisor before applying for a cash out refinance.
Key Components of a Cash Out Refinance:
Cash out refinance is a good financial tool when it is used properly. Over the course of the last years over 8 million plus people have applied for a cash out refinance. This number is only going to increase in the next couple of years. Before you decide to add your name to the list, make sure that you understand the components that are involved in cash out refinance, such as:
- Interest Rate: Before you apply for the refinance you need to ensure that the interest rate on the second mortgage loan is less than your current one.
- Loan Amount: The loan amount you receive should be adequate to improve your finances.
- Monthly Repayments: You should check with your financial advisor if you can adjust the new monthly repayments on top of your current expenses.
- Closing Costs: You need to make sure that the closing costs do not exceed the loan amount otherwise there is no point in refinancing.
Break-Even Point:
A Break-even point helps homeowners determine whether the new mortgage is a feasible investment. By calculating how long it will take to recoup the costs that went into refinancing, such as lender fees, title costs, and third-party costs, etc., borrowers can assess if taking out a cash out refinance is a good investment or not. The savings that you will garner over the life of the cash out refinance comes from lower interest rates and lower monthly repayments.
Step-by-Step Guide to Calculate the Break-Even Point:
You can calculate the break-even point on the cash-out refinance if you follow the given steps.
1. Calculate the Total Refinancing Costs:
Before you start the refinancing process, you need to calculate the overall costs that will be associated with cash out refinance. The costs will include lender fees, title insurance, escrow services, and other costs. You will also need to pay appraisal fees, which are about 2% to 6% of the loan amount. In Texas, you only need to pay 2% closing costs.
2. Determine Your Monthly Savings:
When you apply for refinancing you need to calculate the difference between your current mortgage and the new mortgage’s monthly repayment. The difference in repayments is what you will be saving each month. You should apply for the cash refinance if you see ample savings otherwise the refinancing makes little sense.
Take this example, for instance:
Your old monthly payment was $1,500
After refinancing, your new Monthly payment is $1,200
Your new monthly savings will be: $1,500 – $1,200 = $300
3. Consider the Cash-Out Amount:
One of the benefits that you get when you apply for the cash out refinance is the total sum that you will receive. You have to consider how it will affect your finances in the long run. Cash out refinance doesn’t have direct impact on the break-even calculation but you must consider it as an important part when you consider refinancing.
4. Divide Total Costs by Monthly Savings:
Now that you have an estimate of your monthly savings, you can calculate the break even by dividing it by total refinancing costs by using a simple formula:
Break Even Point: Total Refinancing Costs/ Total Monthly Savings
For example:
The sum of your refinancing costs is $6,000
Your monthly savings is around $300
By using the even formula, we can calculate the break-even point in months:
$6,000 / $300 = 20 months
5. Assess Long Term Savings:
The break-even point gives you a clear estimate how long it will take to recoup your costs. Once the costs have been repaid, it’s important that you look at the long-term savings that you will receive on the life of the loan. You should also take into account the differences in the interest rates of the old mortgage and the new one to understand if there is a considerable change.
6. Factor in Potential Risks:
Cash out refinance is a good equity-tapping option, but you must take certain factors into consideration. As cash out refinance is collateral backed mortgage option which takes your house as collateral. So, if you miss to repay the amount you borrowed you can risk foreclosure and lose your home.
7. Review Your Financial Goals:
Before you apply for cash out refinance you need to take into consideration how you will use the cash out sum. You can use it to pay back your student loans, medical expenses or make renovations to your property. Just make sure that you should ensure that cash out refinance supports your long-term financial objectives.
8. Consult a Financial Advisor:
Before applying for a cash out refinance, you should consult your financial advisor or mortgage professional. You can consult Dream Home Mortgage, as they can help you assess your situation better.
Book A Free Consultation Today!
Now that you have a general idea about the break-even point and how it can help you recoup costs, you can make a sound decision whether to apply for the cash out refinance or not. If you are still on the fence about it, you can consult Dream Home Mortgage. The mortgage brokers will assess your case and help you come to a definite conclusion. Under the stewardship of Mr. Hussein Panjwani, Dream Home Mortgage has helped thousands of families all over the US refinance their properties and unlock the potential of their equity. What are you waiting for? Book a free consultation today!
David Weber is an experienced writer specializing in business and related fields, delivering insightful and informative content for diverse audiences.