If your home is worth significantly more than what you owe on your mortgage, you may qualify for a cash-out refinance.
A cash-out refinance replaces your current mortgage with a new, larger loan. It can be an attractive, low-cost borrowing method to be used for things like home remodeling, vacations or debt consolidation.
How a home cash-out refinance works
A cash-out refinance involves getting a new, larger home loan to pay off your existing mortgage and you get a lump sum. The difference between the old and new mortgage is the “cash out” portion, which goes in your pocket.
For example, say your home is valued at $300,000 and you owe $100,000 on your mortgage. That means you have about $200,000 in equity. To do a cash-out refinance, you need to borrow enough to pay off your existing mortgage and then add how much you want to cash out.
Using our example, say you wanted to cash out $50,000. In this case, you need to refinance your home for at least $150,000 — $100,000 to pay off your previous mortgage, and then you get the $50,000 you wanted in cash.
How much can I borrow with a cash-out refinance?
A general rule of thumb is that you can get an 80% loan-to-value (LTV), which means you’ll need at least 20% of home equity to qualify.
Here’s a quick formula you can use:
(Home value X 80%) — Mortgage balance = Estimated cash-out amount
For example, if your home was valued at $300,000 and you owe $200,000 on your mortgage, the maximum amount you can borrow is $240,000, leaving you with an estimated cash-out amount of around $40,000.
($300,000 X 80% = $240,000) — $200,000 = $40,000 estimated cash-out amount
Can I borrow more than 80% when cashing out?
There are exceptions to the typical 80% LTV rule. The Fannie Mae limited cash-out refinance may loan funds at over 90% LTV. But in general, plan on needing to retain at least 20% equity in your home when refinancing or with other home equity borrowing methods.
This requirement exists because assets can lose value, aka depreciate. If the home’s value drops and you’ve cashed out nearly all your equity, you may find yourself in a negative equity position, which is when your loan balance is higher than the asset’s actual value. If you need to sell your home in the future, being upside down makes things complicated — for you and the lender.
Home cash-out refinance costs
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. Closing costs vary by state, loan type and lender.
Fees rolled into closing costs often include the appraisal fee, property inspection, origination fees, settlement fees, property taxes, homeowners insurance and much more.
When a cash-out refinance is a good idea
Some situations when it makes sense to consider a home cash-out refinance include:
- You have a lot of equity. The more equity you have, the more likely you are to qualify for a cash-out refi.
- Home values are high. If the whole market is up, your home’s value may have also increased, potentially qualifying you for home equity products.
- Interest rates are low. If you got your original mortgage when rates were high, you may be able to get a lower rate on your cash-out refinance.
- You need a low-cost borrowing option. Mortgage refinancing is one of the less-expensive ways to borrow, especially compared to personal loans, which can come with interest rates well into the teens.
- You have high-interest debt. Many borrowers do a cash-out refi to consolidate high-interest debt, which can save a lot of money in the long run. Cashing out your home’s equity can give you the cash you need to pay these loans with a potentially lower interest rate.
- Plans for home improvements. If you want to fix your home, a cash-out refi may be a more affordable way to borrow long-term than personal loans or credit cards.
When it doesn’t make sense to cash-refi your home
It’s not always wise to liquidate your home’s equity, and in situations like these, it may be better to hold off.
- You’re struggling with mortgage payments. Since cash-out refi involves getting a larger loan amount, it will increase the size of your mortgage payments. This may put your home at risk for repossession if you can’t keep up.
- You have poor credit. Most lenders require good credit to cash-out refi a home, often setting the credit score requirement around 670 or higher.
- Interest rates are high. Mortgage rates are based on the prime rate, usually slightly higher than the current prime rate. If the prime rate is high, then you may not get a very favorable rate on the new mortgage.
Remember: A cash-out refinance isn’t free, so it’s best to do it when you can secure a lower interest rate or switch to more favorable terms. And if you don’t want to put your home on the chopping block in the case of default, consider other borrowing methods without collateral, such as personal loans.
5 steps in getting a cash-out refinance
Getting a cash-out refinance takes a little prep work, but fortunately, it’s light.
1. Crunch some numbers
The first step is to determine how much cash you want out of the cash-out refi, and then figure out your home’s equity position.
If you want to use a cash-out refi for home improvements, estimate how much those improvements will cost. Or if you’re cashing out equity for debt consolidation, add up the debts you want to pay off.
Next, figure out how much equity you have in your home. Simply find your current mortgage balance, and then estimate how much your home would sell in the current market. Then just subtract the estimated market value from your mortgage balance.
2. Determine if cashing out makes sense
Once you know your equity position and how much you want to borrow, use this handy-dandy formula to see how much you may be able to borrow:
(Home value X 80%) — Mortgage balance = Estimated cash-out amount
If cashing out your home equity doesn’t yield enough cash for what you want to use it for, it might be time to consider other options. If it seems like it’ll work, onto the next step.
3. See if you qualify
All lenders have unique requirements, but you’ll have the most options if you meet the following criteria:
- Fair or good credit. 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.
- Low DTI ratio. Most lenders like to see a maximum debt-to-income (DTI) of 43%, which means your current monthly debt payments don’t exceed 43% of your gross income.
- 20% home equity. Plan on needing at least 20% equity in your home to get cash out since most lenders offer loans at 80% LTV.
4. Compare cash-out refinancing lenders
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5. Get your home appraised, apply and cash out
Home cash-out refinances need an appraisal, which requires an appraiser to determine your home’s value. The appraisal’s cost is typically around $500 and is often lumped in with closing costs.
If you qualify for a cash-out refinance and are successfully approved, know that closing can take anywhere from 30 to 45 days. And closing costs can be anywhere from 1% to 5% of the loan amount, similar to a traditional mortgage.
Once you receive your funds, you spend it however you need. If you ever struggle with repayments, reach out to the lender as soon as possible to discuss temporary hardship programs or adjusting your repayment terms.
3 cash-out refinancing alternatives
Cashing out your home’s equity isn’t the only way to borrow out of your home, and other borrowing methods don’t involve putting your home up as collateral.
Visit our guide to mortgage refinancing to compare providers and learn more about how refinancing a home loan works.