A cash-out refinance is a type of mortgage refinancing that enables you to cash out your home equity. Your prior mortgage balance is exceeded by the amount of the new mortgage, and the excess is paid to you in cash. Cash-out refinances can be a good option for homeowners who need access to cash and have built up enough equity in their homes to qualify for the loan. Find out more about cash out refinance below.
What is a Cash-Out Refinance ?
A cash-out refinance is a type of refinancing in which a borrower refinances their existing mortgage for a larger amount than what is owed on the current mortgage. The difference between the new loan amount and the current mortgage balance is paid out to the borrower in cash.
Refinancing is a common process in the real estate industry for replacing an existing mortgage with a new one that often offers the borrower more advantageous terms. You might be able to decrease your monthly mortgage payments by refinancing, as well as lower your interest rate, renegotiate the periodic loan conditions, add or remove borrowers from the loan obligation, and, in the case of a cash-out refinance, access cash from the equity in your house.
How Does Cash-Out Refinance Work ?
A cash-out refinance is a type of mortgage refinancing where you borrow more than your current mortgage balance and receive the difference in cash. It works by replacing the existing mortgage on a property with a new, larger mortgage. The borrower applies for a cash-out refinance loan with a lender, who will evaluate the borrower's creditworthiness, income, and other factors to determine if they qualify.
If approved, the lender will pay off the existing mortgage and issue a new loan for an amount that is greater than the current mortgage balance. The difference between the two amounts is paid out to the borrower in cash. The borrower then repays the new loan with interest and fees over the loan term.
For example, suppose a homeowner has a current mortgage balance of $200,000 and wants to do a cash-out refinance for $250,000. The lender will issue a new loan for $250,000, pay off the existing $200,000 mortgage, and give the borrower $50,000 in cash. The borrower will then have a new mortgage for $250,000 with potentially different terms and interest rates than the previous loan. The borrower will be responsible for making monthly mortgage payments on the new loan for the remainder of the loan term, typically 15 or 30 years.
Cash-Out Refinance Example
Let's say a homeowner, John, has a current mortgage balance of $150,000 on his home, which has a current market value of $300,000. He needs $50,000 to pay for home renovations and has built up enough equity in his home to qualify for a cash-out refinance.
John applies for a cash-out refinance loan with a lender and is approved. The lender issues a new loan for $200,000, pays off the existing mortgage of $150,000, and gives John $50,000 in cash. John now has a new mortgage with a balance of $200,000 and potentially different terms and interest rates than his previous loan.
John can use the $50,000 he received in cash for his home renovations, and the additional $50,000 of debt will be spread out over the new loan's term. He will now make monthly mortgage payments on the new loan for the remainder of the loan term, typically 15 or 30 years.
Who is Eligible for Cash-Out Refinance ?
To be eligible for a cash out refinance, you typically need to meet certain requirements set by the lender. Cash-out refinance requirements may vary depending on the lender and the type of loan you are seeking, but some common eligibility criteria include:
1) Equity Requirements:
You must have sufficient equity in your home to borrow against. This typically means having at least 20% equity, although some lenders may allow lower equity thresholds.
2) Credit Score:
Lenders will generally require a minimum credit score of around 620 or higher, although some lenders may require a higher score.
3) Income and Employment:
You must have a steady source of income and be able to demonstrate that you can afford the new loan payments. Lenders will typically require proof of income and employment, such as pay stubs or tax returns.
4) Debt-to-Income Ratio:
Lenders will also look at your debt-to-income (DTI) ratio, which compares your monthly debt payments to your monthly income. Most lenders prefer a DTI ratio of 43% or lower, although some may allow higher ratios.
5) Property Eligibility:
The property being refinanced must meet the lender's eligibility requirements. For example, the property must be your primary residence or a second home (not an investment property), and it must meet certain standards for condition and marketability.
It's important to note that meeting these eligibility requirements does not guarantee that you will be approved for a cash-out refinance. Lenders will also consider other factors, such as your credit history, employment history, and other financial factors, when evaluating your application.
Cash-Out Refinance Rates
Cash-out refinance rates can vary depending on several factors, including the borrower's credit score, loan amount, loan-to-value (LTV) ratio, and the lender's requirements. Generally, cash-out refinance rates are higher than rates for regular refinancing or home purchase mortgages, since they represent a greater risk to the lender.
According to recent data from Freddie Mac, as of May 5, 2023, the average 30-year fixed-rate mortgage rate for a cash-out refinance was 3.45%, while the average 15-year fixed-rate mortgage rate was 2.72%. However, keep in mind that individual rates can vary depending on the factors mentioned above.
Cash-Out Refinance Terms
Cash-out refinance terms can vary depending on the lender and the borrower's financial situation. Here are some common terms you may encounter:
1) Loan Term:
The length of time you will be repaying the loan. Common loan terms for cash-out refinances are 15 or 30 years.
2) Loan-to-Value (LTV) Ratio:
The percentage of your home's value that you can borrow through the cash-out refinance. Lenders typically allow a maximum LTV ratio of 80-85%.
3) Closing Costs:
The fees associated with obtaining the loan, which can include appraisal fees, title fees, and origination fees. These costs can vary depending on the lender and the location of the property.
4) Income and Employment Verification:
Lenders may require proof of income and employment to ensure that you can afford the new loan payments.
How to Calculate Cash-Out Refinance ?
There are several online cash-out refinance calculators available that can help you estimate how much you may be able to borrow and what your monthly payments could be. To calculate a cash-out refinance, you will need to consider the following factors:
1) Home Equity:
The amount of equity you have in your home will determine how much cash you can receive from a refinance. To calculate your home equity, subtract your outstanding mortgage balance from your home's current market value.
2) Loan-to-Value Ratio:
Lenders typically allow you to borrow up to a certain percentage of your home's value, called the loan-to-value (LTV) ratio. To calculate your LTV, divide your mortgage balance by your home's current market value, then multiply by 100.
3) Cash-Out Amount:
Once you know your home equity and LTV ratio, you can determine the amount of cash you can receive from a cash-out refinance. Multiply your home's value by the lender's allowed LTV ratio, then subtract your outstanding mortgage balance and any closing costs.
4) New Loan Terms:
Once you know the cash-out amount, you can determine the new loan terms, including the loan amount, interest rate, and term. Be sure to shop around and compare offers from multiple lenders to find the best deal.
5) Monthly Payment:
To calculate your new monthly payment, use an online mortgage calculator or consult with a lender to determine the estimated principal and interest payment based on the new loan amount, interest rate, and term.
6) Total Interest Cost:
Finally, calculate the total interest cost over the life of the loan, which is the amount of interest you will pay over the entire term of the loan. This can help you determine if a cash-out refinance is a cost-effective option for your financial situation.
Keep in mind that the results of a cash-out refinance calculator are only estimates and may not reflect the actual terms you'll be offered by a lender.
How Much will I Get from a Cash-Out Refinance ?
The amount you can receive from a cash-out refinance depends on several factors, including the amount of equity you have in your home, the value of your home, and the lender's specific requirements. In general, you may be able to borrow up to 80% to 90% of your home's value, minus any outstanding mortgage balances and closing costs.
For example, if your home is worth $500,000 and you owe $250,000 on your current mortgage, you may be able to borrow up to $200,000 through a cash-out refinance, assuming the lender allows you to borrow up to 80% of the home's value. However, keep in mind that the actual amount you can borrow may be lower depending on your credit score, income, and other factors.
How to Get Cash-Out Refinance ?
Here are the steps to follow to cash-out refinance your home:
1) Determine your home equity:
The first step in cash-out refinancing is to determine how much equity you have in your home. You can calculate this by subtracting your outstanding mortgage balance from your home's current market value.
2) Check your credit score:
Lenders will consider your credit score when evaluating your cash-out refinance application. Check your credit score and credit report to ensure there are no errors and to see if there are any areas for improvement.
3) Shop around for lenders:
Look for lenders that offer cash-out refinancing and compare their rates, fees, and terms. Consider both online lenders and local banks or credit unions.
4) Submit an application:
Once you've chosen a lender, submit an application for a cash-out refinance. You'll need to provide documentation of your income, employment, and assets, as well as information about your current mortgage.
5) Get an appraisal:
The lender will typically require an appraisal to determine the current market value of your home.
6) Wait for approval:
The lender will review your application, credit score, and appraisal, and decide whether to approve your cash-out refinance. This process can take several weeks.
7) Close the loan:
If approved, you'll need to sign the loan documents and pay any closing costs associated with the loan.
8) Receive your cash-out proceeds:
Once the loan is closed, the lender will pay off your existing mortgage and give you the cash-out proceeds.
To find the best cash-out refinance loan, it's a good idea to shop around and compare offers from multiple lenders. Consider working with a mortgage broker or using online comparison tools to simplify the process and find the best deal.
It's important to carefully consider the terms, fees, and interest rates of the new loan before deciding to move forward with a cash-out refinance. The best cash-out refinance for you will depend on your individual financial situation and goals.
Pros of Cash-Out Refinance
There are several potential benefits to a cash-out refinance, including:
1) Access to Cash:
A cash-out refinance allows you to tap into your home equity and access cash for a variety of purposes, such as home improvements, debt consolidation, or other expenses. This can be a convenient way to borrow money, since you can often get a lower interest rate than you would with a personal loan or credit card.
2) Potential Tax Benefits:
Interest paid on a mortgage is tax-deductible, which means that a cash-out refinance may offer tax benefits if you use the funds for certain purposes, such as home improvements or investment property. Consult with a tax professional to understand how the tax benefits may apply to your specific situation.
3) Potentially Lower Interest Rate:
Depending on current market conditions, a cash-out refinance may offer a lower interest rate than your current mortgage. This can save you money over the life of the loan, especially if you are refinancing high-interest debt.
4) Simplified Finances:
If you have multiple loans or debts, a cash-out refinance can simplify your finances by consolidating them into one loan with one monthly payment. This can make it easier to manage your finances and stay on top of your payments.
5) Home Value Appreciation:
If your home has appreciated in value since you purchased it, a cash-out refinance can allow you to take advantage of that equity and use it for other purposes.
Cons of Cash-Out Refinance
While there are several potential benefits to a cash-out refinance, there are also some potential drawbacks to consider, including:
1) Higher Loan Amount:
A cash-out refinance typically results in a higher loan amount than your current mortgage, since you are borrowing against your home equity. This can increase your monthly mortgage payment and total interest costs over the life of the loan.
2) Higher Closing Costs:
Like a regular refinance, a cash-out refinance may require you to pay closing costs, which can be several thousand dollars. These costs can add up quickly and offset any potential savings from the refinance.
3) Increased Risk:
Borrowing against your home equity with a cash-out refinance means that you are taking on more debt and increasing the risk of foreclosure if you are unable to make your mortgage payments. It's important to make sure that you can afford the new loan payments before proceeding with a cash-out refinance.
4) Longer Loan Term:
If you choose to refinance to a longer loan term in order to lower your monthly payments, you may end up paying more interest over the life of the loan, even if you get a lower interest rate.
5) Potential Decrease in Equity:
A cash-out refinance can decrease the amount of equity you have in your home, which can be a disadvantage if you plan to sell the home in the near future or if property values decline.
Frequently Asked Questions
How much equity do I need for a cash-out refinance?
Lenders typically require you to have at least 20% equity in your home to qualify for a cash-out refinance. However, some lenders may allow you to borrow up to 80% of your home's appraised value, minus your current mortgage balance.
What can I use the cash-out proceeds for?
You can use the cash-out proceeds for any purpose you choose, such as home improvements, paying off high-interest debt, or investing in other properties or businesses.
How does a cash-out refinance affect my mortgage payments?
A cash-out refinance can potentially increase your monthly mortgage payments, as you'll be borrowing more money and potentially extending your loan term. However, it can also potentially lower your overall monthly debt payments by consolidating debt into a single, lower-interest payment.
Can I get a cash-out refinance with bad credit?
It may be more difficult to qualify for a cash-out refinance with bad credit, as lenders will consider your credit score when evaluating your application. However, some lenders may be willing to work with borrowers with lower credit scores.
What are the fees associated with a cash-out refinance?
Fees associated with a cash-out refinance can include appraisal fees, origination fees, title search fees, and other closing costs. These fees can add up to several thousand dollars, so it's important to factor them into your decision.
What are the risks of a cash-out refinance?
The risks of a cash-out refinance include taking on more debt and potentially extending the amount of time it takes to pay off your mortgage, as well as potentially higher interest rates and fees.
How long does it take to complete a cash-out refinance?
The cash-out refinance process can take several weeks or longer, depending on the lender's requirements and the complexity of the transaction.
How do I choose the right lender for my cash-out refinance?
When choosing a lender for your cash-out refinance, consider factors such as interest rates, fees, loan terms, customer service, and reputation. Shop around and compare offers from multiple lenders to find the best deal.
Is a cash-out refinance right for me?
Whether a cash-out refinance is right for you depends on your financial situation, goals, and needs. Consider factors such as your current mortgage terms, interest rates, and equity in your home, as well as the fees and risks associated with the loan. It's also a good idea to consult with a financial advisor or mortgage professional to determine if a cash-out refinance is the right choice for you.
How long does cash-out refinance take?
A cash-out refinance takes a little bit to process and close, but overall, it should take between 45 to 60 days.
What is the maximum amount of cash I can get through a cash-out refinance?
The maximum amount of cash you can get through a cash-out refinance depends on several factors, including the amount of equity you have in your home, your credit score, and the lender's guidelines. Typically, lenders will allow you to cash out up to 80% of your home's appraised value, minus any outstanding mortgage balance.