Cash-out refinancing
Quick insights
- A cash-out refinance allows you to take out a new mortgage for a larger one, giving you the difference in cash.
- You can use the money for various purposes, such as home improvement, debt consolidation, funding education or investing.
- To qualify, you typically need a good credit score, specific low debt-to-income ratio (DTI) and enough equity in your home.
Are you looking to tap into the financial potential of your home? A cash-out refinance may help. Imagine transforming the equity in your home into cash that can help you tackle projects like that long-awaited kitchen remodel, consolidate debt to lighten your monthly load or even take a family vacation you’ve been dreaming of.
In this article, we will review how cash-out refinancing works and its financial possibilities.
What is a cash-out refinance?
A cash-out refinance is a financing option where you take out a new mortgage for more than what you currently owe on your home. The difference between the existing mortgage loan and new mortgage is provided in cash.
Cash-out refi example:
- Home value: $400,000
- Current mortgage balance: $250,000
- New mortgage amount: $300,000
- Cash received: $50,000 (the difference)
Cash-out refinance requirements:
To qualify for a cash-out refinance, you will need to meet certain financial and equity guidelines. Requirements will vary by mortgage lender and loan program, but common standards often include:
- Enough home equity: You can build equity in your home as you make monthly mortgage payments and property value increases. Many lenders require you to have at least 20% equity after closing on a cash-out refinance.
- Credit score: A credit score in the mid-600s or higher is commonly preferred for conventional loans; however, minimums will vary depending on the lender.
- Debt-to-income ratio (DTI): Mortgage lenders typically prefer a certain DTI, such as 36%. Lenders may accept up to 45% DTI for conventional loans. Some FHA loan programs (Federal Housing Administration) allow up to 50% DTI under certain conditions.
- Stable income and employment: You will need to provide documentation, such as pay stubs, tax returns or other proof of consistent income to show you can comfortably manage the new mortgage payment.
- Appraisal requirement: Most lenders will require a current home appraisal to confirm the value of your property. This determines how much cash you can safely access.
How does a cash-out refinance work?
With a cash-out refinance, the purpose is to make cash available with a new mortgage. You take out more than you owe on your current mortgage, and the balance is given to you after closing.
Let’s say you own a home valued at $500,000 and currently have a mortgage balance of $300,000. This means you have $200,000 in equity, which is the difference between the value of your home and what you owe.
This is different from traditional rate and term refinance, which replaces your existing mortgage with another one. The interest rate and loan term can change (going from a 30-year to a 15-year mortgage, for example), but you don’t receive any cash.
Cash-out refinance process
- Determine the cash amount: Most lenders allow you to borrow up to 80% of your home’s appraised value. In this case, 80% of $500,000 is $400,000. Subtracting your current mortgage balance of $300,000, you could access $100,000 in cash.
- Application: You apply for a new mortgage of $400,000. This new loan will pay off your existing mortgage and provide you with the cash difference.
- Home appraisal: The lender conducts an appraisal to confirm your home’s value, ensuring it meets the necessary requirements.
- Loan approval: After verifying your income, credit score and the appraisal, the lender approves your new mortgage.
- Closing: At closing, your existing loan is paid off. You receive $100,000 in cash, typically as a direct deposit, check or wire transfer.
What can you use a cash-out refinance for?
Here are some common uses for a cash-out refinance:
Home improvements
You can use the cash from a refinance to renovate or upgrade your home, such as remodeling a kitchen or adding a bedroom. For instance, you might use $40,000 to modernize your kitchen, which can increase your home’s value.
Debt consolidation
Cash-out refinancing could help you pay off high-interest debts, like credit cards or personal loans. You consolidate them into a single mortgage payment, potentially at a lower interest rate. For example, you could use $50,000 from the refinance to pay off $20,000 in credit card debt and $30,000 in personal loans, reducing your overall monthly payment.
Education expenses
You can use the funds to cover tuition or other education-related costs for family members, potentially making higher education a little more affordable. For example, a parent might use $40,000 to pay for their child’s college tuition.
Emergency fund
You can build or replenish your emergency savings, providing a financial cushion for unexpected expenses like car repairs. Using $20,000 to create an emergency fund provides a cushion for unexpected expenses like car or home repairs.
Investments
The cash could be used to invest in other opportunities, such as purchasing rental properties or stocks, potentially generating additional income. For example, you might take out $60,000 to buy a rental property for long-term income.
How to qualify for a cash-out refinance
A cash-out refinance carries many of the same requirements as a conventional mortgage or traditional mortgage refinance. Lenders differ, but the common eligibility requirements for a cash-out refinance include:
Good credit score
A healthy credit score demonstrates your ability to responsibly manage your finances and credit. Just like when you applied for your initial mortgage, a cash-out refinance requires a minimum credit score. Exact credit scores vary among lenders and change based on economic conditions. It’s also a good idea to check your credit report for any issues that may cause concern.
Low debt-to-income ratio
Your DTI is your monthly debt divided by your monthly income. Lenders use your DTI to determine whether you can reasonably take on additional debt. The lower your DTI, the better chance you may have of qualifying for a cash-out refinance. Lender requirements vary, but you should aim to have a DTI of 43% or lower.
Loan-to-value ratio
Lenders also use your loan-to-value ratio (LTV) to evaluate your eligibility for a cash-out refinance. Your LTV is the comparison of your mortgage amount to the value of your home. Some lenders won’t allow homeowners to exceed an 80% LTV to secure a cash-out refinance.
Minimum home equity
You need equity in your home before you can secure a cash-out refinance. Equity is the difference between your home's appraised value and how much money you still owe on your mortgage. Homeowners gain equity in one of two ways:
- Paying the principal on your mortgage.
- The value of your home increases.
Lenders want to protect homeowners from owing too much, so many limit the amount you can borrow on a cash-out refinance. A cash-out refinance may require a minimum of 20% home equity, which means you can only refinance up to 80% of the value of your home. VA loans are the exception to the rule. The Veterans Administration allows eligible veterans to refinance up to 100% of the value of their homes.
Pros and cons of a cash-out refinance
Advantages of a cash-out refinance
- Better rates: If interest rates drop or your financial situation has improved, you could qualify for better rates and terms with a cash-out refinance.
- Lower monthly output: Homeowners who use a cash-out refinance for debt consolidation can end up lowering their overall monthly payments. And lower interest rates and a better financial situation may lead to a lower mortgage payment, relieving some financial pressure.
- More cash on hand: Cash-out refinances provide you with more liquid cash. You can use this to save for retirement, do home renovations or make a large purchase.
Disadvantages of cash-out refinances
- Too much debt: Sometimes life circumstances can work against homeowners after a cash-out refinance. You risk accumulating debt you can’t afford to pay off, and you risk a default on your loan.
- Higher payment: It's possible your cash-out refinance results in higher payments than your previous mortgage. You need to make sure the terms of the loan align with your budget.
- Going upside-down: There is a possibility you might owe more than what your home is worth if the value decreases. Many protections exist to help prevent homeowners from owing more than their home is worth, but there is no guarantee.
Alternatives to a cash-out refinance
- Home equity line of credit (HELOC): This flexible loan allows you to borrow against your home’s equity as needed, with a variable interest rate. You can withdraw funds, pay them back and borrow again during the draw period.
- Home equity loan: This is a lump-sum loan based on your home’s equity, typically with a fixed interest rate. It’s suitable for those who need a specific amount for a one-time expense. Chase does not offer this loan product.
- Personal loan: Unsecured loans that can be used for different purposes, typically with higher interest rates than secured loans. They don’t require home equity and can be obtained quickly. Chase does not offer this loan product.
- Reverse mortgage: Available to homeowners aged 62 and older, this allows you to convert part of your home equity into cash without monthly repayments. The loan is repaid when you sell the home, move or pass away. Chase does not offer this loan product.
Is a cash-out refinance a good idea?
It depends on your individual financial situation. Evaluate these factors to determine if it aligns with your financial goals:
- Interest rates: If current mortgage rates are lower than your existing mortgage, refinancing could lower your monthly payment.
- Purpose of funds: Using cash for high-interest debt consolidation or home improvements can provide a good return on investment.
- Loan terms: Extending your loan term may lower monthly payments but could increase overall interest paid.
- Equity position: Ensure you’re comfortable with the amount of equity you’ll be taking out, as this has the possibility to impact future financial flexibility.
- Closing costs: Consider the closing costs associated with refinancing, as they can offset some of the benefits.
Contact a Home Lending Advisor to learn more about a cash-out refinance and how to get things started.
Cash-out refinance FAQs
How do I calculate my home equity?
Determine your home’s current market value by researching recent sales of similar homes in your area or use an online home value estimator. Check your latest mortgage statement or contact your lender for the remaining balance on your mortgage. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, your home equity would be $100,000.
Does a cash-out refinance require a home appraisal?
Yes, a cash-out refinance typically requires a home appraisal to help determine your home’s current market value. This is used for assessing how much equity you can access.
Do I have to pay taxes on a cash-out refinance?
You generally don’t have to pay taxes on the money you receive from a cash-out refinance. The funds are typically considered a loan, not income, so they are not usually subject to income tax. Please consult with a tax professional for personalized advice.
Are there fees for a cash-out refinance?
Yes, there are fees typically associated with a cash-out refinance. Common fees include closing costs, appraisal fee, origination fee, credit report fee and possibly a prepayment penalty fee.
How long does a cash-out refinance take?
Check with your lender for a more accurate estimate based on your specific situation. A cash-out refinance often takes about 30 to 45 days to complete. However, the timeline can vary by lender.
