What Is a Cash-Out Refinance? How Does It Work?
Homeownership is one of the best ways to build long-term wealth. As you pay down your mortgage and your home’s value increases, you’re also building equity—the kind of asset that can come in handy when you need it.
So, what if you need to access some of that equity now? A cash-out refinance lets you borrow against your home’s value and turn it into cash for things like paying off debt, renovating your home, or covering major expenses. Let’s break down how it works and whether it might be the right financial move for you.
If you’re ready to tap into your home’s equity, Rate’s simple and streamlined cash-out refinance process can help you get started!
What Is a Cash-Out Refinance?
A cash-out refinance is when you refinance your original mortgage to borrow more money than what you owe. The additional funds (loan amount) are given to you in cash.
For example, if your home is worth $250,000 and you owe $150,000, you might be able to refinance your mortgage for $200,000, giving you $50,000 in cash.
This type of refinancing is typically used by homeowners who have built up some home equity and want to tap into that equity to meet financial needs.
Whether you're looking to pay off high-interest debt like credit cards, fund renovations, or cover college tuition, a cash-out refinance loan can give you access to the money you need.
However, with this option, you’ll end up with a larger mortgage than before, which means your monthly mortgage payments might increase. It’s also important to weigh the loan-to-value (LTV) ratio, which helps determine how much you can borrow based on the value of your home.
How Does a Cash-Out Refinance Work?
A cash-out refinance lets you borrow more than you owe on your original loan and take the difference in cash. Here’s how it works:
Application Process
You’ll apply with a mortgage lender to refinance your current mortgage. The lender will review your credit score, debt-to-income ratio (DTI), and property value to determine if you qualify.
Your credit score plays a big role in your eligibility, as a higher score generally leads to better mortgage rates.
Loan Approval and New Mortgage
If approved, you’ll receive a new mortgage that pays off your existing mortgage. The difference between your old loan and the new loan balance is the cash you’ll get in hand.
This could be used to cover closing costs, pay off personal loans, or finance any other loan options you might have.
Receiving the Cash
Once your new loan closes, the lender will pay off your old mortgage, and you’ll receive the remaining mortgage balance as a lump sum. It’s important to keep in mind that this is still a loan, which means you’ll be required to pay it back over time.
How Is a Cash-Out Refinance Paid Back?
The repayment of a cash-out refinance works the same way as any other mortgage. You’ll make monthly payments to your mortgage lender for the loan balance. These payments will cover the principal (the amount you borrowed) and interest.
If you took out a larger loan amount, your monthly payments could be higher, especially if you’ve extended the loan term.
If your loan-to-value ratio (LTV) is higher than 80%, you might also be required to pay mortgage insurance. This could increase your monthly debt and add to the total cost of the loan. Be sure to factor this in when calculating whether a cash-out refinance is right for your budget.
Pros and Cons of a Cash-Out Refinance
A cash-out refinance comes with both benefits and drawbacks. Here’s a simple look at the pros and cons:
Pros:
- Access to a lump sum of cash for large expenses like home improvements, debt consolidation, or tuition.
- Cash-out refinancing often offers lower interest rates than personal loans or credit cards.
- The interest may be tax-deductible if used for home improvements on your primary residence but you’ll need to check with a tax professional to make sure this applies to your specific situation.
- You can use the funds for anything, including paying off debt or investing in your home.
Cons:
- Your monthly mortgage payments may increase if you borrow more or extend the loan term.
- If you fail to make your payments it could put you at risk of foreclosure since your home is used as collateral.
- If your loan-to-value (LTV) ratio is over 80%, you may need to pay for mortgage insurance, adding to your overall monthly expenses.
Cash-Out Refinance Requirements
To qualify for a cash-out refinance, you’ll need to meet a few key requirements. These requirements can vary depending on the lender and loan type, but here are the most common factors that most borrowers have to address.
Why Your Credit Score Matters
Your credit score is one of the biggest factors in determining whether you can qualify for cash-out refinancing. In general, the higher your score, the better your mortgage rates will be.
Most lenders prefer a minimum score of 620, though some government-backed programs like VA loans or an FHA loan for cash-out refinancing could offer more flexibility. A higher score also means you might qualify for lower interest payments and a more favorable fixed-rate mortgage loan.
Loan-to-Value (LTV) Ratio
The LTV ratio plays a crucial role in how much cash you can access through a cash-out refi. It compares the size of your new mortgage loan to the appraised value of your home.
Typically, lenders want an LTV ratio of 80% or lower, which means you'll need at least 20% equity in your home to get some of the most competitive cash-out refinance rates.
If your LTV is higher, you may be charged higher interest rates or even be required to pay mortgage insurance. This is important when determining how much cash you can borrow.
Income and Employment History
Lenders will want to make sure you can repay the loan, so they'll check your income and employment history. Having a stable income and a low debt-to-income (DTI) ratio can work in your favor and help increase your chances of approval.
If you’re considering a term refinance to lower your first mortgage payment, solid income is even more critical.
Property Value and Home Equity
The value of your home and the amount of equity you’ve built up will directly influence how much you can borrow. The more equity you have, the more you can access with a cash-out refinance.
If you’ve owned your home for several years or have made improvements, your home equity could be larger. For instance, if you have $200,000 in home equity, you could use a cash-out refi to fund a down payment on a second home or an investment property.
How Much Can You Get With a Cash-Out Refinance?
The amount you can borrow with a cash-out refinance depends on several factors, like your real estate’s value, your credit score, and your LTV ratio. Typically, most lenders allow you to borrow up to 80% of your home’s value.
For example, if your home is appraised at $300,000 and you owe $150,000, you could potentially borrow up to $240,000. The difference ($90,000) is the cash you could receive.
Keep in mind that how much cash you get will also depend on your mortgage loan balance as well as your home’s current market value.
How Much Does Cash-Out Refinancing Cost?
Cash-out refinancing costs can vary depending on factors like your loan amount, credit score, and lender fees, but they typically include the following:
Origination Fees
Usually 1-2% of the loan amount.
Closing Costs
Ranging from 2-6% of the loan, covering appraisals, title fees, and other administrative expenses.
Interest Rate
Cash-out refinance loans often come with slightly higher interest rates than rate-and-term refinances.
Private Mortgage Insurance (PMI)
If your new loan exceeds 80% of your home value, you may need to pay PMI until you build more equity.
The total cost will depend on your financial situation and loan terms, but shopping around for lenders and comparing offers can help you minimize expenses while maximizing your cash-out refi benefits.
Cash-Out Refinance vs. HELOC
While cash-out refinancing is a popular way to access home equity, it’s not your only option. Many homeowners also consider a home equity loan or a HELOC (Home Equity Line of Credit).
Both have their pros and cons, so it’s important to weigh your options based on your financial goals.
Repayment Structure
With a cash-out refinance, you’re replacing your current mortgage loan with a new loan that has a fixed term and fixed payments. This can be great for borrowers looking for stability in their monthly budget.
A HELOC, on the other hand, works like a credit card—offering a revolving line of credit that you can borrow against. It comes with a variable interest rate, so the monthly payments can change over time.
Interest Rates
In general, cash-out refinance interest rates are lower than those on HELOCs, especially if you have a good credit score and a low loan-to-value ratio.
However, HELOCs offer more flexibility in how you use and repay the money, which can be helpful if you only need cash in smaller amounts over time.
Loan Amount Flexibility
With a cash-out refinance, you get a lump sum of cash upfront, which can be ideal if you need a large amount of money all at once—like funding a down payment on a second home or making major improvements to an investment property.
On the other hand, a HELOC gives you access to a revolving line of credit, with flexible borrowing methods.
Access to Funds
Both a cash-out refinance and a HELOC allow you to access cash, but they work differently. A cash-out refinance involves replacing your existing mortgage with a new one. This means you’ll have a single loan with one monthly payment.
In contrast, a HELOC acts as a second mortgage, sitting on top of your existing loan. While a HELOC offers more flexibility, a cash-out refinance may be a better choice for borrowers looking for a fixed-rate mortgage loan with predictable monthly payments.
How to Apply for a Mortgage Refinance
A cash-out refinance is a smart way to tap into the value you've built in your home—whether you're paying off debt, making improvements, or covering big expenses.
If you're ready to take advantage of your home’s potential, Rate’s Cash-out Refinance makes it simple to get the funds you need. Why wait? Start today and unlock the financial flexibility you deserve.
Using funds from a Cash-out Refinance to consolidate debt may result in the debt taking longer to pay off as it will be combined with borrower’s mortgage principle amount and will be paid off over the full loan term. Contact Rate, Inc. for more information
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