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What is a cash-out refinance?
A new, larger mortgage that replaces your existing mortgage so you can get cash out.
Whether it’s remodeling your home or paying off high-interest debt — home equity is wealth you can tap into for any purpose. In this article, we cover how cash-out mortgage refinancing works, the costs and some factors to consider to help you decide if it’s the right option for you.
How a cash-out refinance works
A cash-out refinance replaces your current mortgage with a new one for a larger amount of money. The difference between the old and new mortgage is the “cash out” portion which goes in your pocket. But even after paying closing costs and other fees — you probably won’t be able to tap into all your equity.
Suppose your home is worth $300,000, and you have $100,000 in equity.
Most lenders require you to have at least 20% in equity in your home at the time of refinancing. In this example, that’s $60,000 in equity you can’t touch ($300,000 x 0.20%), leaving you with $40,000 to cash out with a new mortgage ($100,000 – $60,000).
If you need to access more than that, you’ll need to have very good credit, a low debt-to-income ratio, sufficient income, and a lender that’s willing to loan you cash at a higher loan-to-value ratio, or LTV. These lenders do exist but may be harder to find.
When a cash-out refinance is a good idea
Doing a cash-out refinance may be a good idea when interest rates are low and you can use the money in a way that puts you ahead financially.
Here are some situations when it may be a good idea:
- You have high interest debt. If you’re in the process of paying off high-interest student loans or credit cards, a cash-out refi can give you the cash you need to pay these loans off at a lower interest rate.
- You want to make home improvements. If you want to fix up your home, a cash-out refi may be cheaper than other forms of financing like personal loans — and, depending on the type of improvement, the interest may be tax-deductible.
- You want to buy an investment property. Some borrowers use cash-out refinancing on a primary home to put a deposit on an investment property to generate passive income and wealth in the longer term.
Remember: A cash-out refi costs money, so it’s best to do it when you can simultaneously secure a lower interest rate or switch to more favorable terms. If you simply need cash out, there are probably less expensive options, like a home equity loan or home line of credit (HELOC).
Pros to cash-out refinancing
Here are some benefits of a cash-out refinance:
- Can increase your credit score. Once you pay off debt like student loans and credit cards, your credit score could jump up. That’s because your credit score is based on things like how much available credit you’re using and your payment history.
- Interest may be tax-deductible. If the money from your cash-out refi is used for eligible home improvement projects, you can deduct the interest on your new mortgage from your taxes.
- Lets you change your loan terms. When doing a cash-out refi, you can adjust the terms of your loan at the same time. For example: Switch from a variable interest rate to a fixed rate, or change the loan’s repayment period from 15 to 30 years.
- Helps you save on mortgage interest. If you can get even 0.75% deducted from your rate, the reduced interest could save you thousands of dollars off the cost of your loan over the long term.
- May be cheaper than a personal loan. Mortgage rates are generally much lower than the rates on a typical personal loan, especially if you have good to excellent credit.
Cons to cash-out refinancing
Consider some disadvantages to a cash-out refinance:
- More debt to pay back. Doing a cash-out refi means taking on more debt and possibly risking foreclosure if you can’t make the bigger payments.
- Closing costs. Closing costs on a cash-out refinance can run from 1% to 5% of the total loan amount. On a $300,000 mortgage, that’s potentially $6,000 to $15,000.
- Longer payment term. If you switch your term from a 15- to 30-year mortgage, you’ll pay a lot more interest in the long run.
- May not get a better rate. If rates are climbing or your credit score has decreased, you may not qualify for a better rate, even if you can get cash out.
How much money you can get with a cash-out refinance
A general rule of thumb is that you can borrow at 80% loan-to-value (LTV), which means your mortgage can’t exceed 80% of the value of your home. In other words, you need at least 20% equity in your home.
But there are exceptions to this rule, like the Fannie Mae limited cash-out refinance, which may loan funds at over 90% LTV. But the downside is that the more you borrow, the bigger your monthly payment will be and the more interest you pay in the long run.
To learn more about LTVs and how they work, see our resource on LTV ratios.
How to get a cash-out refinance, step by step
Here are the steps to getting a cash-out mortgage refinance:
1. Figure out the dollar amount you need
The first step is to determine how much cash you need.
- Add up the amount of credit card debt you have, plus any projected interest.
- Determine the cost of your home improvement project, adding in unexpected expenses.
- Calculate the balance of your student loans, especially higher interest private loans.
Because you’re taking on more debt with a cash-out refinance, take out only what you need to achieve your goals. Extra cash in your account might tempt you to spend on unnecessary items.
2. See if you meet the loan requirements
Here are the standard requirements for a cash-out refinance:
- Credit score. Most lenders require a minimum credit score of 620 to 680 to qualify, with the best rates going to borrowers with a FICO score of 740 and up.
- Debt-to-income (DTI) ratio. Most lenders like to see a maximum DTI of 43%, which means your current monthly debt payments don’t exceed 43% of your gross income.
- Home equity. In general, you’ll need more than 20% equity in your home to get cash out since most lenders offer loans at 80% LTV.
3. Compare cash-out refinancing lenders
Select See rates to view your personalized rates and narrow down your refinancing options.
We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
4. Give sufficient time for the closing process
While closing times vary by the lender, closing times typically take anywhere from 30 to 45 days, depending on how fast you provide your documentation and how quickly the underwriting team processes your loan.
5. Pay closing and refinancing fees
Closing costs for a cash-out refinance are the same as any type of mortgage: anywhere from 1% to 5% of the total loan amount, depending on the state. Closing costs typically include the appraisal fee, property inspection and recording fees, among other things.
To see average closing costs by state, see our mortgage closing costs page.
6. Take advantage of tax deductions
The good news is that the cash you get from a cash-out refi isn’t taxable by the IRS. You may also be able to deduct the interest and points from the new mortgage if you’re using the cash to make home improvements. These might include adding a new office or installing energy-efficient windows.
Not all types of home improvements qualify — so consult with a qualified tax professional to see what interest you can deduct. Nor can you deduct the interest if you’re using the money for debt consolidation or educational expenses.
A cash-out refi can be a smart choice if you need access to cash, and you can simultaneously secure a lower rate or better terms. But if you don’t plan on staying in the house long enough to recoup your closing costs, you may want to consider alternatives to tapping into your home equity, like a home equity loan or HELOC.
If you’re ready to move forward with a cash-out refi, compare mortgage refinance lenders.
More guides on Finder
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