Given the massive appreciation rates many areas saw in the early part of this decade, creating liquidity has become popular. The best way to convert equity to cash is through a refinance strategy.

From 2000 on, the real estate market in many areas of the country was on steroids. Appreciation rates where in the teens or twenties. Let’s assume you had a home in San Diego in 2000. By the middle of 2005, it may have doubled in value. Yes, a $300,000 home might be worth $600,000. Who said real estate was a slow, conservative investment?!

If you are sitting on a lot of equity, you might decide converting it to usable cash makes sense. This is often referred to as cashing out. It is typically done by refinancing your home, but the term refinance has a broad scope in this application. There are two common ways it is done.

The first approach is to simply refinance your entire home and original mortgage. If you have a home worth $400,000 and you owe $150,000, you can get a new loan for $250,000 and pocket the $100,000. While this is the simple approach, it is not always the best strategy. Why? Well, the terms of your original loan may be better than what you can get now. You might have a fixed rate loan with a low interest rate, for instance. If you refinance, you lose that benefit. So, what can you do?

The second strategy is simply to refinance the free and clear portion of your home. Using our example above, you would get a second mortgage for the difference between the $150,000 you owe and the $400,000 value. Lenders will typically cap the loan at 80 percent of the total value.

This second strategy has a potential catch to it. If you are pulling the money out of the home for non-improvement purposes, you should expect to pay a higher interest rate on the second mortgage. Why? Well, lenders have learned that more of these loans go into default than one would expect. This equates to higher risk for the lender statistically, which means a higher interest rate.

Pulling cash out of a highly appreciated home is a fairly common tactic today. From paying off credit card debt to paying for kids to go to college, it just makes sense. If you are heading in this direction, however, make sure you understand what the refinance will mean to your bottom line.

Dan Lewis is with Great Western Mortgage - providing home loans to borrowers.