What is a cash-out refinance?
Ever thought about tweaking your mortgage to get some extra cash in hand? That's exactly what a cash-out refinance can do for you.
As the name suggests, this type of refinancing allows you to take cash out of your home by swapping out your existing mortgage for a brand new one that's actually worth more than what you currently owe. Why? Because the difference between the new loan amount and your old mortgage balance ends up in your pocket at closing. This process is similar to the usual refinance, but with the sweet bonus of cash upfront. So, if you're looking to get a lump sum for that big project or purchase, a cash-out refinance might just be the ticket.
Cash-out refinancing in action
Let’s say your home is worth $300,000 and you owe $150,000 on your mortgage. You could get a new, refinanced loan for $200,000, use $150,000 of the loan to pay off your mortgage balance, then pocket the remaining $50,000 in cash.
Just remember, because this option replaces your existing mortgage, you’ll have to account for new cash-out refinance rates (either fixed or adjustable), new loan terms and a new payment schedule.
How much cash can you get from a cash-out refinance?
Curious about how much cash you could pocket with a cash-out refinance? It really boils down to a few key factors: the current market value of your home, your credit score, and the specific policies of your lender.
Lenders typically allow you to borrow up to 80% of your home's value, minus whatever you still owe on your existing mortgage. For example, if your home is valued at $300,000 and you owe $150,000, you could potentially get up to $90,000 in cash through a cash-out refinance—provided you meet all the necessary qualifications and adhere to the lender's conditions.
You can exceed 80%, but mortgage insurance may apply. In this case, if you have a favorable rate, it could be a good idea to keep your rate and take cash out using a HELOC.
Have a VA loan? They’re the exception to the 80% rule. The Veteran's Administration doesn't have restrictions on the LTV, but lenders can impose their own restrictions. They typically cap it at 90%. That limit also includes the VA funding fee, if applicable.
Pro Tip
If you have a VA loan, you're in for even better news. The Veterans Administration lets eligible veterans refinance up to 100% of their home's value. So, for veterans, the cash-out option can be particularly powerful!
Calculate your cash-out refinance
To see how much cash you might be able to get, start with the current market value of your home. Then, subtract the amount you still owe on your mortgage. The remaining equity is what lenders look at when they determine your loan amount.
Want to skip the math? Use our handy Cash-Out Refinance Calculator.
Cash-out refinance requirements
When you're looking into a cash-out refinance, you'll find that the requirements can vary quite a bit from one lender to another. It's always best to have a chat with your bank to get the nitty-gritty details. However, we can guide you through some general guidelines to keep in mind:
Debt-to-income ratio
Whenever you apply for a loan, your debt-to-income ratio (DTI) is a big player in the approval game. This ratio measures your total monthly debt payments against your monthly income. To get the thumbs up for a cash-out refinance, most lenders like to see a DTI of 50% or lower. But remember, each lender is different, so double-checking is a good idea.
Curious about your DTI? Here’s a simple way to figure it out: Add up all your monthly debt payments, divide that total by your gross monthly income (that's before taxes), and voila! Convert that number into a percentage, and you've got your DTI.
Credit score
A higher credit score doesn't just open doors to a cash-out refinance—it can also snag you a lower interest rate, which is a big plus since it affects the overall cost of your refinanced loan. Most lenders look for a credit score of at least 620. Not sure where you stand? It's a good idea to check your credit score on each of the three major credit bureaus, TransUnion, Equifax and Experian. Any dips in your score could influence your eligibility and the terms of your loan.
Home equity
Home equity is basically the part of your home that you truly "own." The more equity you have, the more cash you might be able to get your hands on through a cash-out refinance. Lenders usually prefer that you keep at least 20% equity in your home after refinancing.
Seasoning requirement
Despite the name, “mortgage seasoning” has nothing to do with your tastebuds. So, what is it? Mortgage seasoning basically refers to the age of a mortgage, meaning how long you’ve had the loan.
For a cash-out refinance on a conventional mortgage, most lenders require you to own your home for six months before you qualify, no matter how much home equity you’ve built up. For FHA loans, there’s a 12-month seasoning requirement, while VA loan borrowers need to wait a minimum of 210 days.
This helps banks manage the risk of a loan—it shows them that your home’s property value is stable, and you’ve been making on-time payments like the good financial citizen you are.
Pros and cons of a cash-out refinance
A cash-out refinance can be a great solution for homeowners who want cash on-hand for big expenses. But, like everything in life, there are tradeoffs. Here are a few pros and cons to consider before taking the plunge:
PROS | CONS |
|---|---|
Provides access to cash, which you can use however you want: home renovations, medical bills, college tuition, retirement expenses—you name it. | Increases the total amount owed on your mortgage, potentially extending the time it takes to pay off your home. |
Many cash-out refinance rates are lower than other types of loans, like personal loans or credit cards, so you could save on interest over time. | Refinancing involves closing costs, typically 2-5% of the loan amount. These costs can be rolled into the new loan amount, but they’re still a significant expense. |
Interest paid on a cash-out refinance can sometimes be tax-deductible, especially if you use the cash for home improvements. | It will increase the unpaid balance amount. It’s important to borrow only what you need. |
Alternatives to a cash-out refinance
If a cash-out refinance doesn't seem quite right, you have a couple of other options:
- Traditional refinance: You can refinance almost any kind of loan through a traditional refinance also called a rate and term refinance. This involves changing your loan terms, switching to a different loan type, lowering your rate or even changing your lender.
- Home Equity Line of Credit (HELOC): A HELOC works a bit like a credit card but uses your home equity as the credit line. It's a flexible option that lets you draw funds as needed, and you only pay interest on the amount you use. Whether you need to fund a big project or handle unexpected expenses, a HELOC gives you the freedom to access your funds when you need them.
Does cash-out refinancing make sense for you?
It’s a big decision and whether a cash out refinance is the right move depends a lot on your personal situation, your financial goals and what you plan to do with the extra cash. Let's break it down to see if it makes sense for you:
- Lower interest rates: If current interest rates are lower than when you first got your mortgage, you might be in a good spot. Just remember, cash-out refinance rates could be a bit higher than standard refinance rates due to the increased risk of a larger loan amount.
- Using the cash wisely: Think about how you'll use the extra money. Are you looking to improve your financial standing or increase your home's value? If so, cashing out could be a great move. But it's always important to consider how long it will take to pay off the new loan.
- The million dollar question—is it worth it?: Weigh up how many years are left on your current loan versus the term of the new loan. Look at the current interest rates, what your new monthly payment would be, and figure out your breakeven point. That's when you'll have made back the money you spent on the refinancing process. Our cash-out refinance calculator can help you crunch the numbers.
Our advice? Weigh your options carefully and talk to a mortgage specialist who can guide you to the best solution for you.
