Cash Out Refinance
A cash out refinance is when the owner of a property takes out a new loan that replaces the old loan plus an additional amount that the borrower receives as a liquid amount. This cash can be used like any other cash to purchase or invest as they desire.
This is different from a standard refinance in that with a standard refinance the loan is replaced with another similar loan but with a different term, interest rate or interest type. For example, a homeowner or borrower with an adjustable rate loan could refinance into a fixed rate mortgage they thought the interest rates could be moving upward in the near future. This would allow them to get into a predictable mortgage situation during a time of volatility.
Since the last financial crisis, interest rates have been brought down to record lows. Because of this, the opportunity cost of doing a cash out refinance or taking out a home equity mortgage loan is much lower. This is because the interest rate that you would qualify for at the time of this writing is likely to be much lower than it was in the pre-crisis period.
If we were to compare the interest rates on a home loan vs the interest rates of a credit card, or even a personal loan, the difference should be very apparent. Home loans are usually able to command a much lower interest rate than that of a credit card or a personal loan because they are secured by real property which means less risk associated for the lenders.
By consolidating their debts into a mortgage loan, borrowers are able to free up some cash flow. They are able to do this because they are lowering their interest rate, stretching out the payoff term changing their interest type away from the highly credit toxic daily compounding interest rate of a credit card and from stretching the payment term out to the repayment term of the mortgage loan. There are sometimes costs associated with a refinance though so it is in your best interest to talk to a mortgage industry professional so that you may run a return on investment analysis to make sure the associated costs make sense. Most lenders will also have no cost options as well.
People also use cash out refinances, home equity loans and second mortgages because they need liquidity and or cash flow, or to make a home improvement such as adding a pool or solar panels. Rather than come out of pocket for what could be tens of thousands of dollars, they pull money from their equity instead. In any case, make sure you are taking your long term as well as short term goals into consideration before you commit to a loan program.