No cash-out versus cash-out refinancing

No cash-out refinancing occurs when the amount of your new loan doesn't exceed your current mortgage debt (plus points and closing costs). With this type of refinancing, you can typically borrow up to 95 percent of your home's appraised value.

A cash-out refinancing occurs when you borrow more than you owe on your existing mortgage. In this case, you are often limited to borrowing no more than 75 to 80 percent of the appraised value of your property. Any excess proceeds remaining after you've paid off an existing mortgage can be used in any way you see fit, but the best use might be to pay off other outstanding high-interest debt, such as credit card debt.

Cash-out refinancing has certain advantages. The interest rate that you'll pay on the mortgage proceeds will usually be less than the interest rate on the other debts (e.g., car loans, personal loans, credit cards, and even some student loans). Moreover, the interest paid on your refinanced mortgage is generally tax deductible, whereas the interest on consumer debt is not.

There are disadvantages to this approach, too. Your refinanced mortgage is secured by a lien on your home. If you can't make the mortgage payments, the lender can foreclose on your home and sell it to pay the mortgage. Credit card or automobile lenders can't take your house away in this fashion. Moreover, unless you're well disciplined, you could pay off the high-interest (credit card) debt only to run it up again, further damaging your financial position.

If you're going to explore a cash-out refinancing, do it only if all of the following are true:

• Your savings make the refinancing worthwhile, even if it wouldn't give you the chance to repay other debt
• Your savings are "real," due to a lower interest rate or a shorter loan term, and not due solely to tax factors, since tax laws may change
• You're sure that you can afford the new monthly mortgage payment
• You trust yourself (and your spouse) not to run up the repaid debt again

Even if the rate on a new mortgage would be only slightly lower that what you've got now, refinancing is a good idea if your savings will outweigh the costs of refinancing during the time you own the home. If you're unsure how much longer you might live in a particular locale, use recouping your refinancing costs in five years or less as a good rule of thumb.