Cash Out Refinance
- 6 min read
- Cash-out refinancing means replacing an existing mortgage with a larger refinance loan and taking the difference as cash.
- Cash-out refinancing is more expensive than regular rate-and-term refinancing.
- Homeowners should compare the cost of a cash-out refinance to a rate-and-term refinance plus home equity loan because cash-out refinancing is often more expensive.
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Own a home but need extra money? Got a major improvement project you’d like to undertake? Want to pay off high-interest bills? Eager to finance a significant event like a wedding? Consider pursuing a cash-out refinance. Here, you replace your existing mortgage loan and
tap into your home’s equity, which you receive as cash at closing.
Find out how a cash-out refinance works, if you are a good candidate for a cash-out refinance, the eligibility requirements, and when you can expect to receive the money.
What Is a Cash-Out Refinance Mortgage?
You have several choices if you own a home but need extra funds. Apply for a home equity loan or home equity line of credit. Pursue a personal loan. Use your credit cards. Or refinance your existing mortgage loan and take cash out during the transaction, called a cash-out refinance.
“A cash-out refinance is a loan option that allows homeowners to replace their existing mortgage with a new one and take out equity from their property in the form of cash. Customers refinance their loan for a larger amount that is owed, and the difference is paid to them in cash,” says Sean Grzebin, head of Consumer Originations at Chase Home Lending.
A cash-out refi offers the chance to lower your interest rate and finance pressing needs or life goals.
How Does a Cash-Out Refinance Work?
A cash-out refinance is relatively straightforward. You pay off your existing mortgage loan with a new, larger one. The difference between the loan balance you pay off and the new higher loan balance is what you pocket in cash at closing.
“This is different than a traditional rate-and-term refinance. That’s because you’re adding money to your first mortgage balance – thus a larger amount,” explains Mike Bevilacqua, CEO of Dominus Properties in Clarksville, Tennessee.
A cash-out refi requires you to use your home as collateral for the new loan. The risk here is that if you don’t pay your mortgage on time and in full each month, you may lose your home.
“You can get a cash-out refi by finding a lender willing to work with you. The lender will assess the current terms of your mortgage, the remaining balance, and your credit profile. They will then make an offer depending on your underwriting analysis,” says Dmitry Kondratiev with LLC.Services, an attorney based in Idaho.
However, you will likely pay a higher interest rate or more points for a cash-out refinance than you would for a rate-and-term refinance. And considering that mortgage rates have risen recently, it may be challenging to find a loan with a lower rate than your current mortgage.
As with most mortgages, a cash-out refi involves closing costs and fees. These expenses typically range between 2% and 5% of the new loan amount.
“So if you’re taking out a $180,000 loan, you can likely expect to pay closing costs ranging between $3,600 and $9,000,” adds Kondratiev.
What Is Needed to Qualify for a Cash-Out Refinance?
You’ll need to meet eligibility requirements to get a cash-out refi. Per Kondratiev, you’ll need to meet these requirements:
- Home equity of at least 20% after you complete the cash-out refinance
- A new appraisal showing sufficient home value
- Sufficient, verifiable income
- A 620 or higher credit score
- A debt-to-income (DTI) ratio of 43% or less.
“Homeowners who have recently purchased their home may not be eligible for a cash-out refinance, as they have not had enough time to build up sufficient equity,” cautions Gzebin.
LTV and home equity requirements in a cash-out refi
Your loan-to-value ratio, or LTV, is your current mortgage balance compared to the home’s appraised value. You calculate it by dividing your loan amount by your property’s appraised value and multiplying by 100. So if your new refi loan amount is $200,000, and your home has been appraised for $300,000, your LTV ratio would be 66.6%.
“Lenders will use your loan-to-value ratio to evaluate your eligibility to pursue a cash-out refinance. Every lender is different, but generally, most don’t allow you to exceed an LTV of 80%,” Bevilacqua says.
Credit score requirements
You also need a minimum credit score to qualify, depending on the loan type.
“A credit score of at least 620 is needed for a conventional loan cash-out refinance,” notes Leonard Ang, CEO of iPropertyManagement. “An FHA cash-out refinance loan requires a score of 580 or even as low as 500 if you have more equity in your home. And VA and USDA loans have no minimum credit requirement when it comes to a cash-out refi, although individual lenders may set their own credit score requirements.”
According to the Consumer Financial Protection Bureau, a DTI ratio is a calculation of all your monthly debt payments divided by your gross monthly income. This number enables a mortgage lender to determine your ability to manage and repay your debt.
For instance, if you pay $1,500 monthly toward your mortgage plus $100 a month for an auto loan and $400 a month for the remainder of your debts, your monthly debt payments would be $2,000. Let’s say your gross monthly income is $6,000. That means your DTI ratio is $2,000 / $6,000 33%.
“Most lenders require a 43% or lower DTI to qualify for a cash-out refinance,” continues Kondratiev. “However, some lenders accept a DTI as high as 50%, while others demand a lower DTI of 40%.”
Top Reasons to Do a Cash-Out Refinance
Now that you know the rules, requirements, and costs involved, it’s time to ask an important question: Is pursuing a cash-out refinance worth it? The answer depends on your financial situation, job stability, how urgently you need the extra money, and the closing costs involved.
“The past two years of the pandemic required many to stay at home more than ever before,” adds Grzebin. “This encouraged some homeowners to consider improving their space and taking on some renovations they have been planning for a while. A cash-out refinance is one option for homeowners to fund renovation projects or necessary repairs to their homes.”
Putting money into home improvements can be a worthy investment. These efforts can boost the value of your home and, consequently, your equity.
Another reason to consider a cash-out refi is to fund education. Paying for tuition, room and board, and other costs can be expensive, especially if you don’t qualify for free financial aid.
“Also, if you had previously taken an adjustable-rate mortgage and want to switch to a fixed-rate mortgage, getting a cash-out refinance could help. When you refinance, you pay a fixed rate, which can be comforting since you won’t have to worry about changes in the interest rate and can budget in advance,” Kondratiev says.
And if you have substantial high-interest debt hanging over your head, including credit cards that charge interest in the double-digits, it can be wise to pay off those debts with cash taken out during your refi closing.
Just be sure to weigh all your options before committing to a cash-out refinance. It may be better to explore a rate-and-term refinance coupled with a home equity loan or home equity line of credit instead. That’s because surcharges for cash-out refinancing run 0.5% to 4% of the entire loan amount – not just the cash-out part. Typically, cash-out refinancing is most cost-effective when your existing mortgage is relatively small and you are seeking a large cash-out amount.
What are the out-of-pocket costs for a cash-out refinance?
There’s a cost to pursuing a cash-out refinance. You’ll pay closing costs and fees that can add up to 2% to 5% or more of the amount you borrow. Factor this in before committing to a cash-out refinance.
When do you receive the cash during a cash-out refinance?
In many cases, you can expect to receive the cash at closing, typically in the form of a cashier’s check or wire transfer. But attorney Dmitriy Kondratiev cautions that it could take up to three business days to receive funds after closing. This three-day period is your legal right, called a “right of rescission,” put in place to protect the borrower. You have three days to change your mind and rescind the contract. But if you need the money more quickly, you can waive your right of rescission.
How does a cash-out refinance work with an investment property?
Cash-out refinancing works similarly for an investment property as it does for a primary residence. Per attorney Dmitriy Kondratiev, you will take out a new loan for more than your current mortgage debt and get the surplus as cash. But you typically need a credit score of 680 or higher and more than 25% equity in your property to qualify for an investment property. Also, expect to pay a higher interest rate than you would for a primary residence. Additionally, you’ll need cash reserves of greater than 12 months’ worth of mortgage payments or cash reserves that equal 2% to 6% of unpaid loan balances.