With a cash-out refinance, you can pull cash from your home’s equity – imagine it like a bank account that you can use to pay off other debtors, renovate your home, or purchase something you’ve always dreamed of (boat, 2nd home, new vehicle, etc.)!
What is a cash-out refinance?
A cash-out refinance is a type of mortgage refinancing that allows homeowners to borrow money against their home equity by taking out a new loan that is greater than their existing mortgage. With a cash-out refinance, the homeowner gets cash back at closing, which they can use for any purpose, such as paying off high-interest debt, making home improvements, or financing large purchases.
Here’s how a cash-out refinance works:
Let’s say your home is worth $300,000, and you currently owe $200,000 on your mortgage. You would have $100,000 in equity ($300,000- $200,000). If you were to do a cash-out refinance for $250,000, then you would receive $50,000 in cash at closing ($250,000 – $200,000 = $50,000).
In this scenario, your new mortgage would be for $250,000, and you would use the $50,000 cash to pay off other debts or make other large purchases.
How much money can you get from a cash-out refinance?
The amount you can receive from a cash-out-refinance will vary by lender and loan type, but the general rule of thumb is you must maintain at least 20% equity in your home. Most lenders allow you to borrow up to 80% of your home’s value, but it is best to only borrow as much as you need.
To determine your home’s current value, your lender will require an appraisal. The appraiser will inspect your property and consider factors such as its location, size, condition, and recent sales of comparable properties in the area to arrive at an estimated value.
How does cash-out refinancing work?
Cash-out refinancing allows you to tap into your home equity by refinancing your existing mortgage for a higher amount than what you currently owe and receiving the difference in cash. However, the amount you can borrow will vary depending on the amount of equity you have in your home, which is the difference between your home’s current value and the amount you owe on your mortgage.
Here is an overview of the general process:
Consider your loan options: Since you will be replacing your current loan with a new one it is important to consider all your home loan options. Conduct research and discuss your options with your Loan Officer to determine which loan is best for you.
Apply for a new loan: Just like any other mortgage, you will have to apply for a new home loan. Complete your application and provide documentation, such as income verification and proof of homeowner’s insurance.
Obtain a pre-approval letter: Assuming you meet the lender’s requirements, you will obtain a pre-approval letter for your new loan. The new loan will be for a higher amount than your current mortgage, and you will receive the difference in cash at closing.
Cash-out on the difference: The cash from your new loan will be used to pay off your existing mortgage in full. Any remaining funds after paying off your existing mortgage are yours to keep.
Pre-approval based on credit history, debt to income ratio, income, employment and down payment. Approval is subject to eligibility.
What do you need for a cash-out refinance?
The requirements for cash-out refinancing will depend on the lender and loan type but here are some general requirements to keep in mind.
- Sufficient equity: To cash-out refinance, you must have enough equity in your home to qualify.
- Good credit: Lenders will look at your credit score and credit history to ensure you are a trustworthy borrower. Remember that having a higher credit score can increase your chances of getting approved for a loan, and potentially lower your interest rate, saving you money over the life of the loan.
- Income Verification: Lenders will want to see proof of your income and employment to ensure that you can afford the new loan payments. Some common documents include W-2s, tax returns, bank statements, current liabilities, and homeowner’s insurance policies.
- Property appraisal: The lender will require an appraisal of your property to determine its current value and the amount of equity you have. This information is used to determine how much you can borrow.
- Cash reserves: Some lenders may require that you have cash reserves on hand to cover a certain number of mortgage payments in case of financial hardship.
Can you use the cash from a cash-out refinance for anything?
- Lower Interest Rates: You might be able to lock in a lower interest rate than your current rate while pulling from your home’s equity.
- Home Improvement Projects: Many clients use cash-out refinancing to renovate and make improvements to their homes.
- Debt Consolidation: Pay off your high-interest debt to get ahead of your finances and to consolidate your bills into one monthly payment.
- New Vehicle/Boat: Need a new vehicle? Have you always dreamed of owning a new boat? You could use your cash-out refinance to make your purchase. With today’s rates, you might get a better deal than if you had to get a specialty loan.
- Tuition: If you or your child are considering higher education, then you could use the funds from your cash-out refinance to manage the expense.
- Pad Your Savings: Want a larger emergency fund? Use your cash-out to buffer your savings account.
- Investments: Use the funds you’ve earned to make financial investments toward your future.
What do I need to know before considering a cash-out refinance?
While a cash-out refinance can provide you with the funds needed to renovate your outdated kitchen, consolidate your credit card debt, or pay off your auto loan, moving forward with a cash-out refinance is a decision you should seriously consider.
Here are some things to keep in mind:
- How long will you live in your home?
- If you plan on moving in 5 years or less, talk to your loan officer about the financial benefits of refinancing today.
- Can you comfortably afford the new monthly payment?
- Since your mortgage balance will increase, thoroughly review the numbers with your loan officer to determine the cost-benefits.
- Are you comfortable resetting your loan term?
- If you’ve paid down your 30-year mortgage down to 20 years remaining, then are you comfortable resetting your mortgage term back to 30 years? Speak with your loan officer to discuss your financial options.
Cash-Out Refinancing: Pros and Cons
Carefully assess both the advantages and disadvantages of cash-out-refinancing before deciding if this option is right for you.
Pros of a Cash-Out Refinance
- Increase Spending Power: Cash-out refinancing can provide you with more cash on hand to help you meet your personal and financial goals.
- Upgrades can boost your home’s value: Renovations can increase the value of your property depending on the type of improvement you fund with a cash-out refi. Kitchen and bath remodeling are especially successful regarding ROI.
- Potential tax deductions: Typically, you can deduct the interest you pay on your mortgage if the renovation or improvements add value to your home.
- Lower Interest Rate: In addition to accessing your home’s equity, if interest rates have decreased since your first mortgage, you can also secure a lower interest rate.
Cons of a Cash-Out Refinance
- Potentially Higher Interest Rate: If your interest rates have increased since you secured your first mortgage,then you could potentially end up with a higher interest rate.
- Closing Costs: Just like when you purchase, you will have to pay closing costs for your cash-out refinance. These costs can add up so it’s important to plan accordingly. Calculate your home closing costs using our mortgage calculator.
- Foreclosure Risk: When you take out a larger mortgage to access cash from your home’s equity, it is possible for your monthly mortgage payment to increase. In a situation where you cannot pay your mortgage, the lender has the right to take possession of the home.
What is the difference between a home equity loan and cash-out refinancing?
Both home equity loans and cash-out refinancing allow homeowners to leverage the equity in their homes. However, although there are similarities between the two, they both serve different purposes based on a borrower’s specific situation.
With a home equity loan, you can borrow a lump sum payment against your home’s equity. This is a second mortgage and is repaid in fixed monthly installments with a fixed interest rate. On the contrary, cash-out-refinancing allows you to pull cash from your home’s equity by replacing your current mortgage with a new one. The new mortgage will be for a higher amount.
Cash-Out Refinancing: Frequently Asked Questions
What credit score do I need to refinance with cash-out?
The credit score required to refinance with cash-out can vary depending on the lender and the type of loan program you are applying for. However, in most cases, you will need a credit score of at least 620 or higher to qualify for a cash-out refinance. In addition to credit score, lenders may also consider other factors such as your income, employment history, and debt-to-income ratio when determining your eligibility for a cash-out refinance.
When is a cash-out refinance a good idea?
A cash-out refinance can be a good idea when you need to access the equity in your home to pay for major expenses such as home renovations, debt consolidation, or other significant expenses.
Do you get taxed on a cash-out refinance?
This will depend on your specific situation. In most cases, a cash-out refinance is not considered taxable income by the IRS. When you take out a cash-out refinance, you are borrowing against the equity in your home, not earning income. Therefore, the funds you receive from the refinance are not subject to federal income tax. However, there are some situations in which you may be subject to tax on the cash-out refinance. Consult with a tax professional to understand how cash-out-refinancing could impact your overall tax situation.
Do you need an appraisal for a cash-out refinance?
A home appraisal is required by your lender for a cash-out-refinance to determine the current value of your home. This will help determine how much equity you have in your home and how much you can borrow.
Does a cash-out refinance affect my monthly payment?
Yes, a cash-out refinance can affect your monthly mortgage payment. As you will be borrowing more money than your current mortgage and paying interest on the higher balance. It’s important to carefully consider the impact of a cash-out refinance on your monthly payment and overall financial situation before deciding if it’s the right option for you.
How much equity do you need to cash-out refinance?
Home equity is the difference between the current market value of the home and the amount of money still owed by any outstanding loans or mortgages. Home equity is gained by either paying down your mortgage over time or by home value increases due to market trends or improvements. Generally, more than 20% of home equity is needed to cash-out refinance.
I’ve weighed out my options, now what?
Contact our team of loan officers. We’ll answer any questions you may have and will help you decide if a cash-out refinance is the best decision for you and your family.
Connect With A Loan Officer To Learn More
Eligibility and approval is subject to completion of an application and verification of home ownership, occupancy, title, income, employment, credit, home value, collateral and underwriting requirements. Direct Mortgage Loans, LLC is licensed in Maryland. Direct Mortgage Loans, LLC NMLS ID# is 832799 (www.nmlsconsumeraccess.org). Direct Mortgage Loans, LLC office is located at 11011 McCormick Rd Suite 400 Hunt Valley, MD 21031. This is a paid endorsement. Equal housing lender.