A cash-out refinance involves replacing your current mortgage with a new larger loan to take out cash at closing based on the equity in your home.
A cash-out refinance can be an attractive option for those needing a large sum of money, but it's important to understand the process and potential risks involved. This loan type involves replacing your mortgage with a larger one, providing you with the difference between the two in a lump sum.
In this article, we’ll explain the pros and cons of a cash-out refinance, how it differs from a traditional refinance loan and the factors you should consider before deciding if it's the right financial move for you. By understanding the ins and outs of a cash-out refinance, you can decide whether it's a viable option for your financial and mortgage refinance needs.
What is a Cash-Out Refinance?
A cash-out refinance allows homeowners to tap into their home equity and use it for any purpose. However, it’s most commonly used to fund renovations and consolidate high-interest debt. Unlike other loan types that serve as a second lien on your house, this refinancing replaces your mortgage with a new home loan.
Essentially, you’ll apply for another mortgage larger than your current one. If approved, you’ll be paid the difference between the two mortgages and start making monthly payments on your new loan.
“This option can result in a lower interest rate, but it also extends your mortgage term,” says San Diego-based real estate investor Tim Gordon.
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How Does a Cash-Out Refinance Work
A cash-out refinance replaces your current mortgage with a new loan. The new mortgage is for more than you owe on your home, allowing you to take out cash at closing. The amount you can take out is based on the equity you have in your home.
So, what’s equity? Your equity is the value of your home minus the amount you owe on it. Let’s say your home is valued at $250,000 and you have a mortgage balance of $150,000. That means you have $100,000 in equity ($250,000 - $150,000 = $100,000).
If you want to remodel your home for $25,000, you could finance it with a cash-out refinance. You would work with a lender and take out a new mortgage for $180,000. That would allow you to pay off your mortgage ($150,000), cover closing costs ($5,000) and take $25,000 in cash shortly after closing.
Before researching cash-out refinance lenders, ensure you meet the eligibility requirements (though each bank is different):
- A minimum credit score of 620
- A debt-to-income ratio of 50% or lower
- At least 20% equity in your home
You’ll also need the following documents during the application process:
- Your tax returns from the past two years
- W-2s from the past two years
- Pay stubs from the past month
- Bank statements from the past two months
After you submit your application and undergo the underwriting process, the bank will appraise your home to confirm its value. After that, you’ll go through a closing process similar to what you did for your first mortgage.
You should have the money in your account about three to five days after closing. Should you have second thoughts, the Truth in Lending Act gives you three days to back out of the loan without losing money.
Is a Cash-Out Refinance Right For Me?
- Cash-out refinancing allows homeowners to tap into their home equity by refinancing their mortgage for a higher amount than they owe.
- This option allows users to access funds for various purposes such as home renovations, debt consolidation or investment opportunities.
- Cash-out refinancing can save money on interest rates compared to other financing options such as personal loans or credit cards.
- Before proceeding, it’s important to carefully consider the fees, refinancing rates and potential risks associated with cash-out refinancing.
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial professionals and homeowners such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
We worked with San Diego-based real estate investor Tim Gordon for this story. He has used several loan types on investment properties to fund renovations, increase their value and make new purchases.
FAQ
How does a cash-out refinance work?
A cash-out refinance works by replacing your existing mortgage with a larger one. The difference between the two can be used to fund renovations or consolidate high-interest debt. This loan type can help you lock in a lower interest rate and extend your loan term.
What is the downside of a cash-out refinance?
One downside of a cash-out refinance is that it extends your loan term. If you only have five years left on your loan, you may be stuck making payments for another 15 or 30 years.
What's the difference between home equity and cash-out refinance?
The difference between home equity loans and a cash-out refinance is that home equity products are separate from your mortgage, whereas a cash-out refinance replaces your home loan with a new one.
Sources
- Tim Gordon, real estate investor and financial expert at Gordon Buys Homes.
- Office of the Comptroller of the Currency, “Truth in Lending.” https://www.occ.treas.gov/topics/consumers-and-communities/consumer-protection/truth-in-lending/index-truth-in-lending.html
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.