Have you built up a good amount of value in your home over the years? A cash-out refinance lets you cash in that value. American homeowners who refinanced their mortgages were able to save over $2,700 annually on their monthly mortgage payments.
While getting cash from your home’s value sounds great, it’s not always the right option. If mortgage rates go up, getting that new, bigger loan could cost you more in the long run.
In this comprehensive guide, we’ll understand what it is, how it works, and figure out if it is the right move for you.
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Cash-out Refinance
What Is Cash-Out Refinance?
A cash-out refinance is a way to access the equity you’ve built up in your home. Equity is the portion of your home’s value that you own. This ownership stake grows over time through mortgage payments and rising property value.
A cash-out refinance replaces your current mortgage with a new, larger mortgage. The difference between the new loan amount and your existing mortgage balance is the cash you receive. This money can then be used for various purposes, such as home improvements or other financial needs.
For instance, if your home is currently worth $300,000 and you still owe $150,000 on your mortgage, you have $150,000 in equity.
With a cash-out refi, you could borrow up to 80% of that $300,000 value, which is $240,000. After paying off the remaining $150,000 mortgage balance, you would receive the remaining $90,000 in cash.
How Does Cash-Out Refinance Work?
A cash-out refinance lets you tap into your home equity by replacing your existing mortgage with a larger one. You get the difference in cash. Let’s understand the process with an example:
Step 1: Determine Your Equity
The first step is to calculate how much equity you have in your home. This is the difference between your home’s current market value and the remaining balance on your existing mortgage.
For instance, you bought your house 8 years ago for $250,000 with a 30-year mortgage. Your current mortgage balance is $180,000. Recent comparable home sales in your neighborhood suggest your home is now worth around $350,000.
Your home value: $350,000
Remaining mortgage balance: $180,000
Home equity: $350,000 – $180,000 = $170,000
Step 2: Decide How Much Cash You Need
Once you know your equity amount, decide how much cash you need to borrow against that equity. Most lenders cap cash-out refinances at 80% of your home’s value.
As a continuation of the previous example, you want to borrow $100,000 cash to renovate your kitchen and bathroom.
Step 3: Shop Around for Lenders
With your target cash-out amount in mind, shop around and get quotes from multiple lenders. Compare interest rates, fees, and loan terms to find the best deal.
Step 4: Apply and Get Approved
After selecting a lender, you’ll complete a full loan application and go through the approval process. The lender will verify your income, credit, and home value.
Step 5: Close on the New Loan
Once approved, you’ll proceed to closing on the new cash-out refinance loan. This replaces your existing mortgage with a new, larger loan amount.
Continuing from the previous example, at closing, your previous $180,000 mortgage balance is paid off with the new cash-out refinance loan amount of $280,000 (80% of the $350,000 home value).
Step 6: Receive Your Cash
Once the new lender pays off your previous mortgage balance, you receive the difference between the new loan amount and the old balance in cash at closing.
After paying off the $180,000 previous mortgage, you will receive the remaining $100,000 difference in cash at closing to use for the renovations.
What Are the Requirements for Cash-Out Refinancing?
Lenders have strict eligibility criteria to assess a borrower’s ability to repay the new, larger mortgage.
Seasoning Requirement
A “seasoning” requirement means you must have owned the home for a certain period of time before refinancing. For conventional loans, this is typically around 6 months. FHA loans require 12 months of ownership, while VA cash-out refinance mandates at least 210 days (about 7 months).
Debt-To-Income Ratio
Your debt-to-income ratio (DTI) is your total monthly debt payments divided by your monthly gross income. Most cash-out refinances require a maximum DTI ratio of 50% or less, though some loan programs allow slightly higher ratios.
Credit Score
An excellent credit score isn’t necessarily required for a cash-out refinance, but it will help you qualify for the best interest rates.
Many lenders have a minimum credit score requirement in the 620-680 range.
Home Equity
You’ll need sufficient equity built up in your home to qualify. Most lenders require you to maintain at least 20% equity in the property even after the cash-out.
How Much Cash Can You Get on a Refinance?
The amount of cash you can get from a cash-out refinance largely depends on two factors: your home’s current market value and your existing mortgage balance.
Most lenders limit cash-out refinance to a maximum of 80% of your home’s appraised value. So if your home appraises for $400,000, you could potentially borrow up to $320,000 with a cash-out loan.
From that maximum loan amount, you would then subtract your current mortgage balance.
For example, if you owe $200,000 on your existing mortgage, you could receive up to $120,000 in cash ($320,000 new loan – $200,000 old balance = $120,000 cash-out).
However, it’s important to note that some types of home loans, like VA, may be available on more favorable terms, including allowing you to borrow up to 100% of your home’s value.
Is Cash-Out Refinance the Right Decision For Me?
As with any major financial decision, it’s important to consider the pros and cons of a cash-out refinance.
Pros:
- Home improvement cash may make you eligible for tax deductions.
- You get (almost) instant cash for things like repairs, debt, or any other financial need.
- You may get a lower interest rate than your original mortgage.
- You have just one loan payment instead of multiple if you were to take out different loans for different needs.
Cons:
- Your total debt and the repayment period go up.
- Closing costs add thousands to the cost.
- You risk losing your home if you can’t pay the new loan.
What Is the Difference Between a Cash-Out Refinance and a Home Equity Loan?
A cash-out refinance isn’t the only way to access your home’s equity. You could also consider a home equity loan or a home equity line of credit (HELOC). These are separate loan products in addition to your current mortgage, while a cash-out refinance replaces your mortgage entirely.
Bottom Line
A cash-out refinance allows you to leverage the equity you’ve built up in your home as a low-interest source of cash.
However, this ease of access comes with responsibilities. Replacing your mortgage with a higher loan puts your home at greater risk if your finances take a turn for the worse.
Whether a cash-out refinance makes sense depends on your goals, financial discipline, and how much equity you can actually tap.
Be sure to explore all options and shop around for the most affordable rates and terms. When used wisely, a cash-out refinance can be a powerful financial tool for homeowners.
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Frequently Asked Questions
What are typical cash-out refinance rates?
Cash-out refinances loans tend to have higher interest rates than no-cash-out, rate-and-term refinances. However, they are still usually lower than interest rates for alternatives like personal loans, HELOCs, and credit cards. Rates can vary significantly by lender but generally start around 5-6% for qualified borrowers.
How soon can I do a cash-out refinance after buying a home?
Most lenders have a seasoning requirement, meaning you must have owned the home for a minimum period before cashing out equity. For conventional loans, this is typically 6 months; for FHA loans, it's 12 months; and VA loans require 210 days or around 7 months.
How much equity do I need for a cash-out refi?
You'll typically need at least 20% of home equity remaining after the cash-out amount is calculated. So, if your home is worth $400,000, you'd need an existing mortgage balance of $320,000 or less.
