Home values have been on the rise for some time now. For most Americans, their home is their largest source of wealth and principal investment. However, we typically invest in our home and make a monthly payment in order to keep the roof over our head without actually considering other ways we can make the value of our home work for us.
The purpose of this post is to explore the use of the cash-out refinance as a financial tool. In the paragraphs ahead, we’ll discuss using it to build up your emergency savings, invest in something like a retirement or college fund, or use it to invest in stocks or even other real estate.
Emergency Fund
As far as meeting day-to-day expenses goes, people are often OK as long as they can work and the paychecks keep coming in. However, if the furnace goes out or there’s an unexpected medical emergency, maybe not so much.
According to a 2018 employee financial wellness survey from PwC, 41% of baby boomers, 48% of millennials and 51% of Gen Xers believe they don’t have enough emergency savings to cover unexpected expenses. This concern was shared by 52% of women and 42% of men.
Depending on where you get your numbers, the problem may actually be more acute. According to a Bankrate piece from 2017, only four in 10 people would rely on savings in an emergency. The alternative would be to take out loans or rely on credit cards with high interest charges, but doing so in a stressful situation can put you further behind the eight ball.
Experts recommend having 3 – 6 months of daily living expenses available if you had an emergency and couldn’t work for a period of time, but longer is better if you can use it to build a safety net.
If you’re financially able, you can put aside something each month, building up savings over time. However, that takes time and you might already be putting money toward other necessities and future goals.
Your home could be a major source of untapped capital that you can use to build your financial cushion, and you can do that through a cash-out refinance.
Building Retirement Funds
Retirement is another major concern. According to the PwC study, 43% of baby boomers have $100,000 or less saved for retirement. Moreover, 27% of employees aren’t saving for retirement at all. Finally, 42% of employees are retiring later than they previously planned.
Top retirement concerns include running out of money, health issues and health care costs among all age groups. Among baby boomers, the group who will be retiring next, only 45% of them even know how much they’ll need in retirement.
As of 2019, the IRS allows you to contribute up to $19,000 per year to your 401(k). If you’re over 50, you’re allowed to contribute anywhere between $1,000 – $6,000 per year if your plan allows for catch-up contributions. The exact limit for these contributions is based on the type of retirement plan you have. If you’re unsure, refer to your documentation or check with your plan administrator.
If you’re behind in building retirement funds, taking cash out of your home could be an excellent way to shore up your nest egg. It would also happen faster than if you were trying to figure out where to cut money out of a tight budget.
College Fund
It’s no secret that the cost of college continues to go up year after year. Yet for many fields, a college degree is considered a prerequisite for getting your foot in the door. Many people may feel like they want to help their children or grandchildren bear the burden of a college education.
If you’re looking to give a boost to a college fund, one great way to do it is to take cash out of your home because it’s your most valuable asset. Taking out a little bit of equity can mean an infusion of thousands of dollars in your investment in someone’s future.
Making Investments
The stock market certainly has its ups and downs, but if you invest in a broad range of stocks over time – an index fund, for example – research has shown you can make a return of about 7% after inflation. This is based on the assumption that you’re going to buy and hold on to the stock for a long time before selling. People who make trades on a regular basis are subject to more day-to-day volatility in the market and you can also have your investment eaten into by trading fees.
With rates in the high 4% to low 5% range for a 30-year fixed mortgage, you can find yourself making more money in the stock market if you take cash out and make some investments, as opposed to just putting money in a savings account that makes practically nothing.
The stock market is just one example. If you get in the right fund, there is the potential to see better return. If you’re unsure about any particular investment strategy, consult a financial advisor.
Investing in Real Estate
If you’re comfortable becoming a landlord, taking cash out to make a down payment on a rental property could represent a good opportunity to gain passive income.
When evaluating investment property opportunities, one of the important things to look at is capitalization rate. Capitalization rate, or cap rate, is a measure that looks at the percentage of the overall value of the property that you could collect each year in rent after factoring in expenses. For this, you need to know both the value of the property and what you could reasonably expect to charge for a similar property in the area. The higher the cap rate, the better.
In addition to the income off the rent itself, you also have the benefits that come from having a house in general. With each monthly payment you gain equity, and you can use that value to turn into cash for other things down the line. If the property gains value between the purchase and the sale, you also make money on the sale. Home values also typically outpace inflation, sometimes by several percentage points. Although price appreciation has been slowing down, market values have been consistently going up.
Moreover, a market that’s slowing down may actually be beneficial if you’re looking to buy an investment property. Everybody wants to try to get a deal.
The distinct advantage of taking cash out is that it can help considerably with the affordability of a down payment. The minimum down payment on a one-unit investment property with a median FICO® Score of 720 or higher is 15%. If you have a slightly lower credit score or would like to purchase a property with 2 – 4 units, you’ll need a higher down payment of up to 25%.
Check out this post for more information on the investment potential of rental properties.
Cash-out refinances can be a powerful financial tool. If you’re interested in looking at your options, you can get started online or give us a call at (888) 980-6716. If you have questions, feel free to share them with us below.
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