What is a cash-out refinance?
There are two basic ways to refinance an existing home loan, each with unique benefits to the homeowner. A “rate and term” refinance will help the borrower achieve either a lower mortgage interest rate or shorter term (or sometimes even both). A cash-out refinance allows the borrower to access a portion of the equity accumulated in the home as cash. In both cases, the new loan replaces the original one.
While the concept of a cash-out refi may be simple, there are still aspects of the process that are helpful to understand further as a homeowner. Let’s break it down and answer some frequently asked questions around a cash-out refinance.
How does a cash-out refinance work?
A cash-out refi gives you access to the equity in your home. Here, you refinance your existing mortgage into a new one with a larger outstanding principal balance, and pocket the difference. The amount of cash you receive is generally based on the difference between your home’s current value and the remaining balance on the loan, but other factors such as occupancy, whether it is a single-family residence, the loan-to-value ratio, whether there is a second loan on the property, etc. come into play.
For example, if your home is valued at $250,000 and you owe $150,000, the amount of equity you’ve built up is $100,000. If you need $50,000, your new mortgage amount will be based on the total amount you owe plus the cash you receive, or $200,000.
How much can I cash out when I refinance?
Typically, your lender will limit cash-out refinance loan amounts to 80% of your home’s value. For example, if your home is valued at $250,000 and your current mortgage balance is $150,000, you could cash out up to $50,000—because the new loan totals $200,000, which is 80% of $250,000, your home’s current value.
Does my credit score matter?
Yes! Even though you already have a mortgage, your credit score still plays a part in determining your interest rate for a cash-out refi. And to be eligible, your credit score must meet the lender’s minimum standards. If it’s lower than the minimum required by the lender, look here for some simple ways to boost your score.
Cash-out refinance vs. home equity loan: what’s the difference?
While both allow the borrower to take out equity, they are quite different. With a cash-out, you’re refinancing your original mortgage and replacing it with a new mortgage that starts from scratch. A home equity loan is a new, additional loan on your home, leaving your original mortgage payment unchanged, but adding a second payment on top of it (and a second lien behind it).
Is a home appraisal required?
In order to do a cash-out refinance, in most cases you must go through the appraisal process This is one of the most crucial steps in the refinancing process, as it establishes the market value of your home, which will determine how much money you’ll be able to cash out.
How long does a cash-out refinance usually take?
It depends on the lender, but it generally takes between 45 and 60 days days to close on your loan from the day you apply.
What do most homeowners use the cash for?
Homeowners choose to cash out their home’s equity for a variety of reasons, often to help pay for major expenses. Here are some of the most common uses:
- Paying down high interest credit card debt: With high credit card interest rates (and relatively low mortgage rates), this often makes good financial sense.
- College tuition: If your children are close to college-aged, consider helping fund their education via a cash-out refinance.
- Home improvement projects: Renovating your home may even help increase its value and build more equity!
Can you do a cash-out refinance on an FHA loan? VA loan?
Yes and yes! An FHA loan allows you to cash out up to 85% of the property’s current value and usually requires less documentation than a conventional cash-out refinance. The VA loan process is quite similar to the FHA, but a VA loan cash-out refinance allows you to pocket up to 100% of the home’s value. See if you meet a VA loan’s requirements.
Do I have to pay closing costs?
Yes, with a cash-out refinance, you are still responsible for closing costs. The amount will vary based on where you live, the property you’re refinancing, and the type of loan you choose.
Will I have a lower interest rate with a cash-out refi?
That depends on a few variables, including your current interest rate, your credit score and loan-to-value ratio. If you only want to lower your rate and don’t need cash, a rate-and-term refinance makes more sense.
Is my monthly mortgage payment going to change?
Yes, in most cases your payment will increase. Since your new loan will consist of your original balance plus the desired cash amount, you can expect the loan and payment size to go up in exchange for cold hard cash.
The cash-out refinancing process may sound confusing, but a little refi know-how goes a long way. Take a look at our Refinance Resources hub for more information.
Ditech is not a financial advisor and the ideas outlined above are for informational purposes only. They are not intended as investment or financial advice and should not be construed as such. Consult a financial advisor before making decisions regarding important personal financial matters, and consult a tax advisor regarding the deductibility of interest.