What Is a Cash-Out Refinance?

Refinancing a home is a fairly common practice, allowing you to change the term of your loan, your interest rate, or both. By shortening the loan term, you can pay it off faster. And if you want lower monthly payments, you can choose a longer term.

But a cash-out refinance is different. It has all the options of a traditional refinance, with the addition of—you guessed it—taking cash out. With this option, your new mortgage amount will be higher than the amount you owe on your home—part of it going to paying off your existing mortgage in full, and the rest of it being the cash you’re taking out.

As a plus, a cash-out refinance provides you with a way to access the equity in your home through a first mortgage, rather than a home equity loan or line of credit, which both require the addition of a second loan.

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How does it work?

When you apply for a cash-out refinance, you’re essentially replacing your existing mortgage with a new one that covers the value of your home. Since it’s a new mortgage, you pay closing costs, which you can pay in cash or roll into the balance of your new loan. After paying off the remaining balance of your mortgage, you receive the difference in the form of a check that you can use however you see fit.

When you apply for a cash-out refinance, you’ll most likely need to have your home appraised. Home values change over time, so yours may be worth more (or less) than what you originally paid for it. Your current home value will determine your new mortgage amount and how much cash you receive.

In most cases, you must leave at least 10% to 20% equity in your home, which means you can’t actually borrow your home’s full value. The higher amount of equity required usually applies to conventional and FHA loans, while it may be closer to 10% for VA loans.

So, how much can you get? Let’s say your home’s value is $350,000, and you still owe $150,000. If the maximum loan-to-value ratio is 80%, you multiply your home’s value by 0.8, which leaves you with a new loan of $280,000. You then subtract your current mortgage balance ($150,000) from the new one, which leaves you with $130,000 cash.

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A cash-out refinance replaces your existing mortgage with a new one that gives you access to the equity you’ve built up in your home.

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What are the requirements?

While a cash-out refinance can provide you with a decent chunk of change, you have to satisfy some requirements in order to get one, including:

• At least 20% equity in your home
• A credit score of at least 620
• A debt-to-income ratio of less than 50%
• A new home appraisal

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Qualifying for a cash-out refinance requires at least 20% equity in your home, a good credit history, and a debt-to-income ratio of less than 50%.

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Pros and Cons of a Cash-Out Refinance

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Pros

You may decrease your interest rate.

Depending upon the current interest rates, your cash-out refinance may result in a lower interest rate than your original mortgage. If you only want to lock in a lower rate, a standard refinance may make more sense. But, if you want the equity too, a cash-out refi may be the better choice.

The mortgage is tax-deductible.

Just like your original mortgage, the interest you pay for your refinance loan is tax-deductible. Keep in mind, however, that only the portion of the refinance used to pay off your original mortgage is tax-deductible. You can only deduct interest paid on the full amount if you use the cash to make home improvements.

You can use the funds however you want.

There are no restrictions on how you can use the funds you receive from refinancing your home. You can invest in home improvements, consolidate high-interest debt, fund your child’s college education (or your own), or use it for anything else you might need.

You can boost your credit score.

If you use the money you receive from your cash-out refi to pay off credit cards, you decrease your credit utilization ratio. In doing so, your credit score improves. Making your loan payments on time also helps to boost your credit.

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Cons

It can lengthen your loan term (but doesn’t have to).

By refinancing and getting a new loan, it can increase your loan term. meaning that you may be making payments on your home for longer than you intended. Even if your interest rate decreases, you may still end up paying more in interest over time.

Your monthly payments may increase.

If your cash-out refi comes with a higher interest rate, your monthly payments may increase, even if you have a longer repayment term. The primary goal of a cash-out refi is to improve your financial situation. Review your new loan carefully before you sign anything to make sure it will help you in the long run.

You have to pay closing costs.

As with any refinance, you’ll have to pay closing costs for your new mortgage. They typically run 2% to 5% of your loan’s total. While you can roll the costs into your loan, doing so increases the amount you need to repay. It may also lead to a higher interest rate. Additionally, borrowing more than 80% of your home’s value reestablishes the need for private mortgage insurance.

There’s a risk of foreclosure if you default.

A cash-out refinance is just like any mortgage—if you default on your payments, you run the risk of losing your home.

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With a cash-out refinance, you can lower your interest rate and use the funds however you need.

What Can You Use a Cash-Out Refinance For?

You can use the money from your refinance on anything you want—yes, even a new kitchen. Of course, what you can do with the money depends on how much you receive, but you have the freedom to spend it in just about any way you choose.

A few common ways to spend that cash include:

Home improvements

Dreaming of a new kitchen? Perhaps you’re contemplating a bathroom remodel, redoing your attic to make a home office, or adding an extra room.

No matter what your home improvement dreams are, the cash from your refinance can make them come true. What’s more, using the cash portion of your refinance for home projects means you can deduct the interest for the entire balance of your new loan.

When done right, taking cash out to make improvements can be a great way to improve the resale value of your home.

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Refinancing high-interest debt

Credit cards often come with very high interest rates—often three to five times as much as mortgage rates. If you don’t pay off the balance each month, you can end up paying thousands in interest.

Using cash-out refinancing, you can pay off your high-interest credit cards or other high-interest debts. The interest paid on the cash used for this purpose isn’t tax-deductible, but it can help to save you a substantial amount of money overall. Not to mention, paying off your credit cards reduces your credit utilization, which can improve your credit score.

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Paying for college

A cash-out refi offers a lower interest alternative to traditional student loans. While it may make for an appealing option to pay for higher education, you should consider a few factors first:

• Paying off a lower-interest loan over 20 or 30 years could cost more in interest than paying off a higher-interest student loan in 10 years
• Student loan interest (up to $2,500) is tax-deductible, the cash from your refinance isn’t
• Some student loans may be eligible for forgiveness

Weigh your options carefully to determine if using a cash-out refinance is the best option for funding you or your child’s college education. 

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Buying a second home

If you’re looking to buy a second home (such as a vacation home), a cash-out refi can help you do just that. You can use the equity in your current home to put money down on another property, or, depending upon the amount of money you receive, pay the full cost in cash.

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You can use the equity in your home to pay off high-interest credit cards, fund your child’s college education, or get the new kitchen you’ve always dreamed of.
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Cash-Out Refinance Tips

Cash-out refinancing provides access to the equity you’ve accumulated in your home, allowing you to use it in any way you see fit. To ensure success, here are a few tips to keep in mind:

• ‍Plan ahead. Closing on a cash-out refi generally takes 45 to 60 days.
• Know where you stand. Even with enough equity in your home, you still need to meet specific requirements to qualify for a cash-out refinance. To see where you stand, get in touch with our team here at Lower.‍
• Consider all of your options. A cash-out refi has some significant benefits, but it’s not your only option for accessing equity. Compare it with other solutions such as a home equity loan and a home equity line of credit to find the best choice for you.
• ‍Exercise caution. Your home’s equity can be a great way to pay off high-interest credit card debt. Just be careful you don’t rack up new balances and fall back into the same situation.

A cash-out refinance gives you access to your home’s equity, which you can then use for home improvement projects, refinancing higher-interest debts, paying for college, and more. Weigh the pros and cons of this solution to make sure it’s right for you.

Ready to get started with your cash-out refinance? We’re here waiting to help!