3 Bad Reasons to Do a Cash-Out Refinance

A woman signing paperwork in an office.

Image source: Getty Images

Mortgage refinance rates are very low these days, so a lot of borrowers are getting new home loans to take advantage of them. Now, when it comes to refinancing, you have choices. You could do a standard refinance where you borrow your exact mortgage amount, or you could do a cash-out refinance where you borrow more than what you owe on your home and then use the extra money for whatever purpose you'd like.

In some situations, a cash-out refinance can be a smart move. But here are three bad reasons to get one.

1. To take a vacation

After the year we've all had grappling with the pandemic, we could all use a getaway -- maybe even an extended one. But borrowing money to take a vacation isn't usually a financially sound move.

Remember, a cash-out refinance is still a loan. When you do one, you wind up with a larger mortgage balance than what you started with, and while you may manage to snag an affordable interest rate on your new mortgage, it's debt nonetheless. A better bet is to take a low-key vacation now if that's all you can swing, and then work on saving up enough money to take a longer, more extravagant one down the line.

2. To maintain a lifestyle you can't afford

If you've been falling behind on your bills for quite some time, you may be tempted to do a cash-out refinance. That way, you could use the extra money to supplement your income and keep up with your bills.

But actually, that's not a great idea. If you consistently can't cover your living expenses, it means you're spending too much. And if so, your best bet is to set up a budget so you can track your spending and start cutting back in areas where you have the most wiggle room.

3. To pay off a very small credit card balance

If you have a large amount of credit card debt in your name, then a cash-out refinance could be a good way to pay it off. Imagine you owe money on a credit card charging 22% interest, and you can refinance your mortgage at 3.2%. If you take the proceeds from your cash-out refinance and use that money to pay off your credit card debt, you'll save yourself a lot of money on interest, so doing that makes sense when your credit card balance is substantial.

But if you only owe, say, a few hundred dollars on a credit card, then a cash-out refinance may not be as cost-effective as you'd think. That's because you'll pay closing costs on the amount you borrow that could easily end up equaling 5% of your loan. If your credit card debt is minimal, you may be better off seeking out a balance transfer credit card offer instead.

A cash-out refinance could help you consolidate large debt, make improvements to your home, or pay for expensive repairs you've been putting off. But don't do a cash-out refinance if your goal is to spend money on something you can't afford, maintain a lifestyle you can't really swing, or pay off a minimal amount of debt. There are better ways to address those issues, and if you do a cash-out refinance in any of those situations, you might end up regretting it.

A historic opportunity to potentially save thousands on your mortgage

Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.

Our expert recommends this company to find a low rate - and in fact he used them himself to refi (twice!). Click here to learn more and see your rate.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Latest Markets Videos

    The Motley Fool

    Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

    Learn More