Josephine Nesbit8-Minute Read
UPDATED: August 17, 2023
We all have debts and expenses that we’d take care of if we had an extra $20,000 laying around. Unfortunately, it can be hard to save that kind of money on top of paying for basic living costs.
But there’s good news. A mortgage refinance, specifically a cash-out refinance, allows homeowners to free up the valuable equity they’ve built in their homes. This money can be used on everything from home renovations to paying off other loans or even financing a vacation.
Here’s what you should know about cash-out refinances and why it might be a good option for you.
A cash-out refinance is a type of refinance that allows homeowners to borrow money against the equity they have built up in their homes. With a cash-out refinance, the homeowner takes out a new mortgage that is larger than their current mortgage balance. The existing first mortgage is paid off and the difference between the two loans is paid out in cash to the homeowner.
You can refinance and withdraw some of your equity, usually up to 80%, as cash that you can spend. So, if you had $60,000 worth of equity, you might be able to withdraw around $48,000 to use for renovations, paying off other loans, etc.
When you do a cash-out refinance, you essentially get a new loan, borrow more than you owe on the existing mortgage and take the difference in cash from your lender. You are then free to use this money however you wish. So, let’s say you bought a house for $300,000 and you’ve paid off $70,000. You still owe $230,000 on the mortgage. Maybe you want to renovate your kitchen and bathrooms and it’s going to cost around $30,000.
If you want to use a cash-out refinance to pay for your renovations, you can add the amount of equity you want to borrow to what you currently owe on your mortgage for a new loan amount. In this case, that would be the $230,000 that you owe plus the $30,000 you need. Your new mortgage would be for $260,000 – the original $230,000 that you owed plus the $30,000 that you’ll receive as a lump sum after closing.
Applying for a cash-out refinance is similar to a traditional mortgage refinance, but you may also need at least 20% equity in your home to qualify.
A cash-out refinance calculator is a simple way to figure out how much you can borrow in a cash-out refinance. A calculator can also help you determine your new monthly mortgage payment after refinancing.
You may need to gather basic information, like your home’s current value, how much you owe on the mortgage, how much you would like to borrow and the loan term. You may also have the option to input additional factors that could affect the overall cost, like the interest rate, property taxes and other fees.
Or, you can try a calculator function similar to the one offered by Rocket Mortgage®.
There are a few things to consider before getting a cash-out refinance. You will need to determine how much money you will need, the type of cash-out refinance, what interest rate you may qualify for, the terms of the loan and more.
Before applying for a cash-out refinance, it’s important to determine how much money you need. Additionally, there may be a limit on how much you can withdraw. Most types of cash-out refinances cap withdrawals at 80% of the equity you’ve built in your house.
Refinance rates will specify how much you pay in interest, which will cost you less over the life of the loan. For most homeowners, monthly payments typically increase after a cash-out refinance because you are borrowing more than you owe on the mortgage. But, if you are able to get a lower interest rate than you did when you applied for your first mortgage, your monthly payment could go down or remain the same.
There are several types of cash-out refinance options, and each type has its own rules and guidelines. Here are several cash-out refinance options:
When you take out a home loan, you and your lender will agree to a set of conditions that outlines what is expected of you over the life of your loan. Your loan terms specify the amount of time you have to pay off the mortgage. Loan terms vary, but 15-year and 30-year loans are the most common. The shorter your loan term, the higher your monthly payment may be.
Similar to a traditional refinance, there are closing costs associated with a cash-out refinance that could affect the total borrowing amount. Closing costs are typically between 2% – 3% of the principal on your mortgage. While a cash-out refinance can offer better interest rates, the closing costs can be higher.
The breakeven point refers to the point at which you save money on a refinance. You should calculate the breakeven point on your cash-out refinance so that you know you can recover the overall cost to refinance. You can do this by taking the total cost to refinance your home loan and dividing it by monthly savings if you refinance. This tells you the number of months it will take to breakeven.
Appraisals are required for a cash-out refinance. This provides your lender a professional opinion about what your home is currently worth. This tells you how much home equity you’ll be able to borrow against.
The cash-out refinance process is similar to a traditional refinance. To qualify, you must meet your lender's requirements and have a certain amount of equity in your home.
Here are the requirements and qualifications needed for a cash-out refinance.
There are plenty of reasons to refinance your home. A cash-out refinance is a great option for homeowners who have built some equity in their home and need to free up money for a financially beneficial purpose.
For example, if you owe money on student loans or are paying on other debts, you could use a cash-out refinance to pay off those debts and “transfer” the money to a place where the debt will accrue interest at a much lower rate – your mortgage. The interest rate on a credit card and other loans are often very high, sometimes above 20%, while your mortgage rate is likely less than 10%.
Cash-out refinances are also a good idea for homeowners that might need to make major home improvements or repairs – especially ones that increase home value like kitchen remodels, appliance upgrades, etc. If you just want to take out money to invest for your retirement or another upcoming cost, this may be a good option too.
If you’re looking for ways to make the most of your equity, refinancing isn’t your only option. Let’s go over a few other ways you can access the value you’ve built in your home.
Below are some of the advantages and disadvantages of a cash-out refinance.
Cash-Out Refinance Pros
Cash-Out Refinance Cons
You can fund expensive projects, like a bathroom renovation.
Just like any other refinance, you’ll have to pay closing costs again – which could be a few thousand dollars.
It’s a tool to tap into that otherwise inaccessible wealth to pay for things like credit card debt, investment properties, and any other expenses.
It could take a few days after closing to finally see your money.
By using a cash-out refinance, you can consolidate or “transfer” other debts to a place where they’ll accrue much less interest.
Unless you have a VA loan, you can usually only withdraw 80% of the equity you’ve built in your house.
Using a cash-out refinance to make upgrades can potentially boost your home’s value.
When you refinance, your loan terms will be different, meaning your monthly payment might be higher or lower and the loan could take longer to pay off.
The following are answers to frequently asked questions about cash-out refinancing.
You can withdraw up to 80% of your home’s equity. However, a VA cash-out refinance allows borrowers to take 100%.
You can use the funds from your cash-out refinance on anything you want. It’s typically recommended to use the extra cash for a financially beneficial purpose.
You need at least 20% equity in your home before refinancing. With a VA loan, you can potentially do a cash-out refinance with no equity.
The money you receive from a cash-out refinance isn’t free money or a capital gain, so there are no cash-out refinance tax implications. You don’t have to list the amount you cashed out on your taxes as taxable income.
This depends on your interest rate and the loan amount. Most homeowners generally see a higher monthly payment, but if you qualify for a lower interest rate than your original mortgage, your monthly payment could be lower.
Yes, a cash-out refinance will impact your credit score. This happens not only because your lender does a hard inquiry while applying for the loan, but also because you are taking on a new loan.
A cash-out refinance is a way to use the hard-earned equity you’ve built up in your home for whatever you need it for – whether that be consolidating debt, renovations, or any other big cost that may come up in your life.
If you think you’re ready to refinance, you can get started on the application today.
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