Complete Guide to a Cash-Out Refinance

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Building equity in your home is one of the benefits of paying off your mortgage. However, you don’t need to fully pay off your mortgage or sell your property to tap into this equity.

Cash-out refinancing offers an alternative solution for many, allowing you to tap into the accumulated equity for cash while still making mortgage payments. Let’s take a closer look at what exactly is involved with a cash-out refinance and if it’s right for you.

What is a Cash-Out Refinance?

A cash-out refinance allows homeowners to turn their home’s equity into cash. It is a type of mortgage refinancing where the borrower takes out a new mortgage for an amount larger than their existing mortgage, and the difference is received in cash.

Simply, you borrow more than you owe on your mortgage and pocket the difference. The funds from a cash-out refinance can be used for any purpose, such as home remodeling, college tuition or other financial needs.

How Much Cash Can You Get From a Cash-Out Refinance?

Your home’s current market value primarily determines the total amount you can borrow through a cash-out refinance. To start this process and understand how much you might be eligible to borrow, an essential step is to have your home professionally appraised.

Lenders generally use this appraisal value to set a limit on how much they will lend. A common standard in the industry is to allow homeowners to borrow up to 80% of their home’s appraised value. However, this is not a fixed rule and can vary significantly among different lenders, depending on various factors.

Our refinance calculator can help you understand how much you can borrow, your new monthly mortgage payment and whether a cash-out refinance is right for you.

How a Cash-Out Refinance Works

Step 1: Home equity

First, you need to have equity in your home. Equity is the portion of your home that you truly own, which is the value of the home minus any outstanding mortgage balances.

For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, your equity is $100,000.

Step 2: Check cash-out refinance requirements

Lenders set their own requirements when it comes to qualifying for a cash-out refinance. However, there are some common factors across the board.

Most lenders and loan types require a credit score of 620 to refinance your current mortgage, a debt-to-income ratio less than 45% to 50% and at least 20% equity in your home. There are also wait times, or seasoning periods, to be aware of. Make sure to check with your lender since these can vary.

Step 3: Determine how much cash you need

It’s important to determine how much cash you need so the difference between the old mortgage loan and the new loan is enough to supplement your needs. If you’re planning to use the cash for repairs, it’s a good idea to get a few estimates from contractors in your area so you know how much you need.

Step 4: Receive the cash

After your lender finalizes everything, the new mortgage closes and your original mortgage is paid off. Any remaining amount is given to you in cash. This cash can be used for various purposes such as home renovations, paying off high-interest debts, funding education or investing.

The new mortgage will have different terms than your original loan, which might include a different interest rate or loan length, so make sure you are aware of these before proceeding.

Cash-Out Refinance vs. Home Equity Loan

When homeowners are looking to leverage the equity in their homes for additional cash, they often consider either a cash-out refinance or a home equity loan.

While both options provide access to home equity in the form of cash, they differ significantly in terms of loan structure, interest rates, loan terms and the overall impact on the homeowner’s financial situation.

Cash-Out RefinanceHome Equity Loan
Loan StructureReplaces the existing mortgage with a new, larger mortgageA second loan in addition to the existing mortgage
Loan AmountUp to 80-90% of the home’s value (including new mortgage)Up to 80-85% of the home’s value minus the existing mortgage
Loan TermOption to reset loan term (e.g., 30 years)Fixed term, usually 5-15 years
Funds ReceivedDifference between new and old mortgage in cashLump sum amount
Interest RatesTypically lower, as it is a primary mortgageSlightly higher than a primary mortgage
Closing CostsSimilar to standard mortgage refinanceGenerally lower than cash-out refinance

Pros and Cons of a Cash-Out Refinance

When considering a cash-out refinance, it’s essential to weigh its advantages and disadvantages to make an informed decision. Here’s a breakdown of the key pros and cons:

Benefits of a Cash-Out Refinance

  • Access to cash: Provides you access to a lump sum of cash, which can be used for various purposes like home improvements, debt consolidation, education expenses or investments.
  • Potentially lower interest rates: Since it’s a secured loan, the interest rates are often lower than unsecured loans like credit cards or personal loans, potentially saving you money over time.
  • Tax deductions: Interest paid on a cash-out refinance can sometimes be tax-deductible, especially if used for home improvement. However, it’s best to consult with a tax advisor first.
  • Debt consolidation: If used to pay off high-interest debts, it can simplify your finances into one lower-interest payment, potentially helping you manage debt more effectively.
  • May improve credit score: Paying off credit card debts with this loan can lower your credit utilization ratio, which is a key factor in determining your credit score.

Disadvantages of a Cash-Out Refinance

  • Time-consuming: With a cash-out refinance, you still have to go through the loan process, including underwriting. This can take anywhere from a couple of days to a few weeks. If you need immediate funds, there may be better options than a cash-out refinance.
  • Risk of foreclosure: Since your home is collateral for the loan, failure to make payments could lead to foreclosure.
  • Closing costs: Refinancing does still involve closing costs. This cost can be substantial for many, typically 2-5% of the loan amount.
  • Longer payoff time: If you extend your loan term, it could take longer to pay off your home, resulting in more interest paid over time.
  • Potential for negative equity: If home values decrease, you could end up owing more on your mortgage than your home is worth. Make sure to consider factors like your neighborhood or location before jumping to a cash-out refinance.

Evaluating your financial situation and consulting with financial professionals before proceeding with a cash-out refinance is advisable.

Differences Between Cash-Out Refinance and No Cash-Out Refinance

Normally, refinancing a mortgage will mean that you are replacing an existing mortgage with a new one. Both mortgages will have the same amount, but the new one will have a lower interest rate or be for a shorter period. In some cases, the new mortgage will have an amount that is less than the outstanding balance of the existing loan. Sometimes, the new mortgage will both have lower interest rates and a reduced loan term. This type of refinancing is considered a no cash-out refinance.

With a cash-out refinance, you will get the chance to withdraw a percentage of your home equity in one lump sum of cash. Due to the nature of a cash-out refinance, it is usually advised that homeowners put a lot of thought into the way they use the money that is withdrawn. For example, using the cash to get a new degree that can help you earn more income is a wise option, but using it to start a high-risk business isn’t.

If what you are looking for is to lower the interest rate of your existing mortgage or change the loan term, then you should go for a refinance without a cash-out. However, if you are looking to tap into the equity of your home and withdraw money to fund major home or personal projects, then a cash-out refinance is ideal.

Is a Cash-Out Refinance Right For Me?

Deciding whether a cash-out refinance is the right option for you largely depends on your new loan’s terms and what you intend to do with the cash. It’s recommended to use these funds on ventures that offer a return on investment, such as home improvements or debt consolidation.

Opting for a cash-out refinance to fund vacations or purchase a new vehicle may not be the best choice financially, given the long-term nature and costs of the loan.

It’s important to remember that with a cash-out refinance, your home serves as collateral. Make sure to prioritize timely repayments in full to avoid the risk of foreclosure.

Frequently Asked Questions

How does refinancing a loan work?

The idea of refinancing a loan is simply replacing your current loan with a new loan. The new loan could have a different rate, loan term, or amount.

How long after refinance do I get the money?

It typically takes 3-5 days after a cash-out refinance before you receive your funds.

How much cash-out can I get on a refinance?

It depends on the lender and loan type, but typically lenders allow you to withdraw between 80-85 percent of your home equity.

Can you pull money out of your house?

Yes, you can pull money out from the equity of your house. If you need funds to carry out major projects such as remodeling your house and paying school fees, you should consider taking a cash-out refinance.

David Mully

David Mully is president and CEO of Lender Insider, a mortgage consulting firm. With 26 years in the mortgage industry, he has worked as both a mortgage loan officer and in the business-to-business sector of the industry. He is the former author of the weekly “Mortgage Search” column for Observer and Eccentric Newspapers. You can read his blog at http://www.lenderinsider.com/blog.

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