If you need extra funds for large purchases, or simply want to obtain a better interest rate on your home loan, refinancing may be a good option. Today, many homeowners are taking advantage of a cash-out refinance.

There are several advantages to refinancing a home. Moreover, refinancing also involves certain pitfalls. Before choosing to refinance your mortgage loan, carefully consider the benefits and risks.

What is a Cash-Out Refinance?

A refinancing is an approach that involves creating a new mortgage loan. You have the option of refinancing with your current lender or choosing a new mortgage lender. When refinancing, the old loan is replaced, and you begin making mortgage payments to the new lender.

Homeowners refinance for many reasons. Because of low mortgage rates, refinancing for a low rate is perfect for lowering monthly payments. Additionally, those with an adjustable rate mortgage usually refinance to acquire a low fixed rate.

Refinancing is also beneficial for obtaining extra funds. The option of cash-out refinancing involves creating a new mortgage, while borrowing some of your home's equity. Hence, the new mortgage amount will exceed the previous amount. For example, if the old mortgage was $100,000, and a homeowner refinances and borrows $10,000 from the equity, the new mortgage principle totals $110,000.

Benefits of a Cash-Out Refinance

A cash-out refinance is ideal for homeowners needing extra funds for large expenses. For example, if your home is older and requires several upgrades, a cash-out refinance is great for financing the project. Moreover, the funds received may be used to start a business, plan for retirement, payoff personal debts, college expenses, etc.

Risks Involving a Cash-Out Refinancing

The money from a refinance is received at closing. The funds are dispersed as a lump sum of money. In most cases, homeowners may borrow up to the home's equity. While tempting, it is important to avoid borrowing too much money. Because a cash-out refinancing increases your previous mortgage principle, your monthly payments may also increase.

Prior to applying for a cash-out refinancing, make sure you can afford the additional expense. For example, you must pay closing fees. You have the option of including the closing fees in the mortgage. However, this will also increase the total mortgage principle. To avoid the risk of foreclosure, the new mortgage amount and payment should fit comfortably into your budget.

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Carrie Reeder owns ABC Loan Guide, an online resource with information about Mortgage Brokers Online and Bad Credit Mortgage lenders online.