Cash-Out Refinance

Get the money you need by cash-out refinancing

Privacy Secured  |  Advertising Disclosures
 

What is a cash-out refinance?

A cash-out refinance is a new mortgage in which the loan amount exceeds what’s owed on your existing mortgage. You receive the difference between the two loans in a lump sum and can use the funds for any purpose. 

Let’s say your home is worth $350,000 and you have a $150,000 mortgage, which means you have $200,000 in available home equity. You want to borrow half of that amount ($100,000), so you decide to refinance into a $250,000 mortgage and pocket the extra $100,000 in cash.

How much can you get from a cash-out refinance?

Mortgage refinance lenders usually require you to have at least 20% equity — or a maximum 80% loan-to-value (LTV) ratio — to qualify for a cash-out refinance. 

Using the example above of a $350,000 home with a $150,000 mortgage balance, you’d have roughly 57% equity before refinancing. After refinancing into a new $250,000 mortgage, you’d have about 29% equity remaining. While you only tapped $100,000, you could’ve accessed up to $130,000 and still retained 20% equity.

A cash-out refinance calculator can give you an estimate of how much equity you can access, based on your home value and LTV ratio. However, it’s best to avoid overborrowing by only tapping the equity you actually need.

How does a cash-out refinance work?

A cash-out refinance serves two purposes: improving your mortgage terms and allowing you to borrow against your home equity. 

This differs from a traditional “rate-and-term refinance,” which involves making changes to your mortgage rate or repayment term. You could use this type of refinance to switch from an adjustable-rate mortgage to a fixed-rate mortgage, shorten your loan term from a 30-year to a 15-year loan or simply get a better mortgage rate and save on your monthly payments.

Reasons to consider a cash-out refinance

Before you leverage your home equity through a cash-out refinance, you first need to know for what purpose you’ll use those funds. Common reasons to use a cash-out refi include: 

  • Funding home improvements. That bathroom or kitchen remodel could finally happen with the lump sum you’ll receive from a cash-out refi. 
  • Buying an investment property. You could dedicate a chunk of your home equity to cover a down payment on an investment property that will bring in rental income.  
  • Consolidating debt. If you have high-interest debt from credit cards, personal loans or other credit lines, you can consolidate that debt at a lower rate. 
  • Paying for college costs. You could cover tuition, books and other higher education expenses for your student or yourself. 
  • Starting a small business. Whether it’s a bakery, boutique or other venture, you may decide on tapping your home equity to start that business you’ve previously put on hold.

Pros and cons of cash-out refinance

Pros

  • You can use the cashed-out equity for any purpose
  • You can expect a lower interest rate compared to other financing options
  • Your interest charges may be tax-deductible (if you use the funds to make home improvements)

Cons

  • You’ll need at least 20% equity to qualify
  • You’ll lose some of the equity you’ve built
  • You’ll pay refinance closing costs, which range from 2% to 6% of your new loan amount

How to qualify for a cash-out refinance

If you’re interested in a cash-out refinance for a conventional loan or one backed by the Federal Housing Administration (FHA) or U.S. Department of Veterans Affairs (VA), you must meet the following general requirements to qualify: 

Minimum credit score 

  • Conventional loan: 620 
  • FHA loan: 500 (with 10% down); 580 (with 3.5% down)
  • VA loan: 620

Maximum DTI ratio

  • Conventional loan: 45%* 
  • FHA loan: 43%* 
  • VA loan: 41%* 

*You may still qualify with a slightly higher DTI ratio if you have a higher credit score or more home equity. 

Maximum LTV ratio 

  • Conventional loan: 80% 
  • FHA loan: 80% 
  • VA loan: 90% 

You can also expect to pay for a home appraisal to verify your home’s value. 

NOTE: Loans insured by the U.S. Department of Agriculture (USDA) aren’t eligible for cash-out refinancing.

Cash-out refinance vs. home equity loan

A cash-out refinance is just one of a few ways that homeowners can tap their equity; another option is a home equity loan

A home equity loan is a lump sum that is repaid in fixed monthly installments. It’s also called a second mortgage, because it’s second in line to be repaid — after the first mortgage used to buy your home — if you lose your home to foreclosure

While a cash-out refinance replaces your existing mortgage, you’ll keep your current loan intact but add another monthly payment by taking out a home equity loan. Home equity loans also tend to have higher interest rates than cash-out refi rates. 

You’ll pay closing costs with both loan types.

Other cash-out refi alternatives

Besides the home equity loan option discussed above, here are a few other alternatives to a cash-out refinance: 

  • Home equity line of credit. A HELOC is another type of second mortgage that works similarly to a credit card. You receive a credit line and only make payments based on how much you borrow, plus interest. 
  • Personal loan. An unsecured personal loan typically comes with a higher rate and shorter repayment term options compared with a cash-out refi, but your home wouldn’t be used to secure the loan so there’s no risk of losing it if you default.
  • Credit card. While it can help in a time crunch, a credit card should be a last-ditch effort to access the funds you need. This is especially true if your interest rate is close to the national average of nearly 15%.

Additional cash-out refi FAQs

It can take several days after your refinance closes to receive your cash. There’s a three-business-day right of rescission on refinance loans, which allows you to cancel the transaction for any reason. If you decide to move forward, your new lender will then pay off your old loan and you’ll receive your cashed-out equity after that point.

Since you’re taking out a new loan to replace your existing mortgage, your credit score and history will be impacted. New credit makes up 10% of your credit score and affects the length of your credit history. This change typically causes a drop in your credit score.

A limited cash-out refinance also replaces your current mortgage, but only for a slightly higher amount to cover the closing costs. You’re allowed to receive up to $2,000 or 2% of your new loan amount in cash, whichever is less. The cash doesn’t come from your home equity, but from the difference between the estimated and final loan payoff amounts.

Yes, you can sell your home after going through the cash-out refinance process. However, it’s best to calculate your break-even point — the amount of months it would take for you to recoup your refi closing costs — before selling. If you decide to sell before then, you’ll essentially lose money with a refi.

Yes, you may qualify for a cash-out refinance on a second home or an investment property, but you won’t be able to borrow as much equity. Lenders limit the LTV ratio for cash-out refis on second homes and investment properties to 75%, meaning you’ll need at least 25% equity after closing.

A cash-out refinance may impact your mortgage interest deduction, which allows you to deduct the loan interest you paid over the year from your taxable income. Unless you use your cashed-out equity to cover a home improvement project on the home that secures the refinanced loan, you won’t be able to deduct the interest you pay on that portion of your loan. You may still deduct the interest paid on the remaining portion of your loan, though.