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- A cash-out refinance replaces your current mortgage with a new, larger mortgage.
- This process lets you turn some of your home equity into cash at closing. Typically, you can't take out more than 80%.
- Cash-out refinances can be a good alternative to home equity loans or personal loans, but there are drawbacks.
If you need access to cash to reach big financial goals, there are plenty of ways to borrow money, such as using a credit card or taking out a personal loan.
If your home's value has increased since you bought it — or you've paid down your mortgage quite a bit, you may be able to get the funds you need through a cash-out refinance on your mortgage.
Cash-out refinance rates are lower than credit cards or personal loans. They're also typically lower than home equity loans or HELOCs since they're first mortgages, so they're considered less risky for the lender.
What is a cash-out refinance?
There are two main types of refinances: Rate-and-term refinances and cash-out refinances. Rate-and-term refinances are used to change the interest rate and terms of your loan — usually to make your monthly payments more affordable or to pay less in interest. Cash-out refinances allow you to borrow from your home equity.
Definition
A cash-out refinance is a mortgage that lets you turn the equity in your home into cash at closing. With a cash-out refinance, you take out a mortgage larger than the amount you still owe on your house, and you receive in cash the difference between what you owe on your current mortgage and the new cash-out mortgage.
How it works
The amount you're allowed to receive in cash may depend on your lender, but as a general rule of thumb, you can't borrow more than 80% of your home's value. This way, you keep at least 20% of your equity in the home.
Let's say your home is valued at $250,000, and you have $100,000 left to pay on your initial mortgage. This means you have $150,000 in home equity.
To determine the maximum amount you could take out, multiply your home's value by 80%, or 0.80. Then, subtract your current mortgage balance to find out how much cash you could potentially get at closing.
250,000 × 0.80 = 200,000
200,000 − 100,000 = 100,000
So in this example, you could take out a loan up to $200,000, pay off your existing $100,000 mortgage, and pocket the remaining $100,000.
Keep in mind that you'll still pay the additional costs that come with taking out a home loan, including appraisal fees, origination fees, and closing costs.
Uses for cash
The money you receive with a cash-out refinance can be used however you see fit. Often, homeowners will use this cash for things like debt consolidation or making home improvements.
How a cash-out refinance works
A cash-out refinance works much like taking out a traditional mortgage does. See below for an overview of the process:
Application process
First, you'll fill out an application with a lender, and submit any documentation they require. This means pay stubs, W-2s, tax returns, and bank statements, usually.
Your lender will then order an appraisal to confirm your home's value, and start to underwrite your loan. At that point, your loan officer may request more documentation or have questions for you. Make sure to respond quickly to prevent any delays. Finally, you'll close on the loan.
Closing costs
When you refinance your mortgage, you'll have to pay closing costs, which cover your lender's fees, the cost of the appraisal, and other items. You'll usually pay between 2% and 6% of your total loan amount on closing costs.
While some lenders let you roll this into your loan balance, that means higher payments and more in long-term interest costs.
New loan terms
A refinance replaces your old loan with a new one. That means you'll get a new interest rate, and you could potentially have a different loan type, loan term, and payment. It's important to understand how your loan will change when you refinance, so you can ensure it still fits within your budget and long-term financial goals.
Pros and cons of cash-out refinancing
As with any financial product, there are advantages and drawbacks to choosing a cash-out refinance. Here are the cash-out refinance pros and cons you should consider before pursuing one.
Pros
- Lower interest rates: Just like with regular refinancing, you might be able to secure a lower interest rate when you use a cash-out refinance. It just depends on what your current rate is and whether current rates are higher or lower. You'll also likely get a lower rate than on other financial products, too (credit cards, personal loans, home equity loans, etc.), making them a more affordable way to pay for expenses.
- Debt consolidation: Because mortgage loans tend to have lower rates than things like credit cards and other loans, they're a good option for consolidating debt — and paying less interest on that debt in the long run.
- Home improvements: There are no rules for how you use the money from your cash-out refinance. Many homeowners use them to make improvements or add onto their properties, improving their value (and equity) even more.
- Tax benefits: If you use the money from your cash-out refinance to make improvements on your home, you may be able to deduct your mortgage interest payments from your taxes, according to the IRS Publication 936.
Cons
- Increased debts: With cash-out refinances, you take out a larger loan than your current one, which means a bigger mortgage balance and potentially higher payments.
- Longer loan term: Refinancing could mean a longer loan term — and a longer payoff period. If you opt for a new 30-year loan, for example, you'll be paying interest for another 30 years (rather than just the remaining years you had on your previous loan.
- Closing costs: Refinances come with closing costs just like a typical mortgage — usually 2% to 6% of the loan amount.
- Risk of foreclosure: If you can't make monthly mortgage payments, you risk your lender foreclosing on your home. Doing a cash-out refinance might result in higher monthly payments, private mortgage insurance, or a higher rate, which could make it harder to make payments. Before you take out cash, consider whether doing so will be a financial strain.
Who qualifies for a cash-out refinance
Whether a cash-out refinance is right for you depends on your goals, how much money you need, and your overall financial situation. To qualify, you'll need to meet the following:
Equity requirements
Most lenders require you to have at least 20% equity in your home — after refinancing — to qualify. This means that your new loan balance can't amount to more than 80% of your home's value.
So, if the appraisal affirms your home is worth $400,000, your new loan could be no more than $320,000.
Credit score requirements
The exact credit score you'll need for a cash-out refinance depends on your lender and loan program, but you can usually expect to qualify with a 620 or higher. Credit scores on the higher end will get you the best interest rates and terms, though, so try to improve your credit score before you apply for your refinance.
Debt-to-income ratio
Lenders will look at your debt-to-income ratio when qualifying you for a loan, as it shows how much of your income your debt payments take up (and subsequently, how much cash you have free for your new mortgage payments).
DTI requirements vary by loan product and lender, but you can usually expect to need a 43% DTI or lower — including your new mortgage payment.
Cash-out refinance vs. other options
Cash-out refinancing isn't the only way to borrow cash. You can also opt for:
Home equity loans
These are a type of second mortgage that let you borrow from your home equity. They come with a second monthly payment and usually have higher interest rates than refinances and other first-lien mortgage loans.
As with cash-out refinances, you can use the funds from your home equity loan however you like.
Personal loans
Personal loans are another option, though these typically come with much higher interest rates than mortgages and home equity loans. They also come with a second monthly payment.
FAQs
It depends on your home's equity, your financial situation, and lender guidelines. You can usually borrow up to 80% of your home's appraised value (so $320,000 on a $400,000 house). Use a cash-out refinance calculator to get any idea of what you can borrow and what your monthly payment may be.
It depends on current interest rates and your financial goals. If the cash-out refinance rates in 2024 are higher than the rate on your current loan, it may not be wise. Consult a financial advisor to assess if it's right for you.
The length of the refinancing process depends on the lender, but you can typically expect it to take anywhere from 30 to 45 days.
Both let you borrow from your home equity. However, home equity loans are a second mortgage and come with a second monthly payment. They also tend to have higher interest rates. Cash-out refinances replace your current loan, leaving you with just one monthly payment.
Cash-out refinances: Conclusion
Cash-out refinancing can allow you to borrow from your home equity without taking on a second monthly payment. You can use the funds as you wish, and you'll typically enjoy lower interest rates than you would on other financial products, like credit cards or personal loans. On the downside, it does mean a larger loan balance and a higher risk of foreclosure.
If you opt for a cash-out refinance, make sure to shop around for your loan, and compare terms, rates, and fees to ensure you get the best deal. And if you need more personalized help, reach out to a mortgage broker or loan officer for guidance.
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