You are now leaving our website and entering a third-party website over which we have no control.
What Is Cash-Out Refinance? And How Could It Benefit Me?
Key takeaways
-
A cash-out refinance replaces your mortgage with another loan, letting you convert home equity into a lump-sum payout
-
Many lenders typically cap borrowing at 80% of the home's value and require you to have at least 20% equity in your home
-
Besides turning equity into ready funds, the benefits can include lower interest rates, an opportunity for debt consolidation, and flexible terms
A cash-out refinance takes advantage of the equity you've built up in your home and converts it into cash.
With a cash-out refinance, your existing mortgage is paid off and a new mortgage established for a greater amount, tapping home equity. The difference becomes a cash payout that can be used to meet a variety of financial needs.
That's the cash-out refinance definition, but there's more to it. In this article, we'll explain how cash-out refinancing works, its pros and cons, and when it may be a good option for homeowners.
How does a cash-out refinance work?
How a cash-out refinance works is similar to regular mortgage financing with one difference: In order to qualify, most lenders require you to have at least 20% equity in your home with the existing mortgage and have lived in your home a certain length of time.
Let’s review the typical steps for cash-out refinance.
1. Determine your available home equity and potential loan amount
Calculate the value of your home and subtract the balance of your current mortgage. For example, if your home is worth $400,000 and you have $200,000 remaining on the mortgage, the equity is $200,000, or 50%.
Most lenders will let you borrow up to a combined loan-to-value limit of 80%. Since 80% of $400,000 is $320,000, that's the total amount you could borrow. If you borrowed that amount as your cash-out refinance mortgage, you would have $120,000 available ($320,000 - $200,000) as the maximum cash-out limit. With your new $320,000 mortgage, you would still have $80,000 in equity on your $400,000 home.
2. Choose a lender and make an application
Shop available interest rates from a variety of lenders. With a cash-out refinance calculator, figure out what your new mortgage payment would be and whether it's affordable for you. If the numbers work out, apply at your preferred lender.
3. Complete the underwriting process
The lender will likely require an appraisal for a cash-out refinance of your property. In addition, they will look at your credit history and credit score, your debt-to-income ratio, and whether you meet seasoning and occupancy requirements. (The minimum credit score for a cash-out refinance is typically around 620. Seasoning refers to how long you've owned the property, and occupancy confirms that it's your primary residence.)
The lender may or may not offer you the maximum cash-out limit. Also, underwriting may take weeks, so if you need the money urgently for a home repair, the cash-out refinance timeline may not work for you.
4. Close on your new mortgage
Cash-out refinance closing costs typically are 2% to 5% of the total loan amount. You might have the option of paying them up front or rolling them into the new mortgage, which could mean a slightly higher monthly payment and paying interest on those closing costs for many years.
5. Begin making payments on the new mortgage
Be sure you understand the terms of your new mortgage—including the monthly payment and the length of the loan. Since your previous mortgage has been paid off, you may have 30 days without any payment.
Benefits of a cash-out refinance
A cash-out refinance can shore up your finances, as long as you can get favorable terms. Here are some of the benefits of a cash-out refinance.
1. Potentially lower interest rate
You may be able to obtain a lower interest rate if your current mortgage was obtained during a period of higher rates.
2. Consolidation of high-interest debt
Many homeowners use cash-out refinancing to pay off debts with higher interest rates, such as:
- Credit card balances
- Personal loans
- Medical bills
- Auto loans
3. Funds for major expenses
Cash-out refinancing provides lump-sum cash that can be used for many purposes, including:
- Home repairs or renovations
- College costs
- Large purchases
- Investments in real estate or retirement accounts
4. Ability to adjust your mortgage terms
We mentioned interest rates, but a cash-out refinance could enable you to gain mortgage terms that are more beneficial to you in other ways, including:
-
Loan term. You could spread out payments with a 30 year term or shorten the term of your loan to, for example, 15 years to minimize the amount of interest you pay
-
Mortgage structure. Depending on your current finances, you might prefer to switch from a fixed-term to an adjustable rate mortgage, or from an ARM to a fixed to a fixed rate
Drawbacks of a cash-out refinance
It's important to understand cash-out refinance pros and cons. Here are a few potential concerns:
1. Higher mortgage balance
Perhaps you've been paying down your mortgage principal. A cash-out-refinance will push that balance back up.
2. Longer repayment timeline
If you have been making payments for 10 years on a 30-year term, a cash-out refinance could reset that timeline back to 30 years. This might complicate your plans for retirement.
3. Closing costs
Before the closing, ask for a list of the estimated closing costs, which could include expenses like the appraisal, credit reviews, and possibly a flood certification. Some costs are negotiable, such as origination fees, title insurance, and application fees.
In any case, expect closing costs to total 2% to 5% of your payout.
4. Your home as collateral
The mortgage is secured by your property, meaning that failing to make payments on time and in full could result in foreclosure.
Before signing on the dotted line, make sure your budget will be able to handle what could be a larger monthly payment.
Cash-out refinance vs. home equity loan vs. home equity line of credit
A home equity loan is another form of equity borrowing that many homeowners choose. Let's look at the key features of cash-out refinance vs. a HELOAN.
Cash-out refinance
To review some of the key features, a cash-out refinance:
- Replaces your entire mortgage, meaning you have only one loan to pay back
- Lets you tap your home equity for a lump sum of cash that can be used for a variety of financial needs
- May offer a lower interest rate than your existing mortgage, depending on market conditions
- May have higher underwriting requirements
- Includes significant closing costs
- Gives you tax-deductible interest
Home equity loan
A home equity loan, or HELOAN, is separate from your primary mortgage. A HELOAN:
- Is a second mortgage, meaning a second monthly payment on top of your existing mortgage
- Doesn't affect the interest rate on your existing mortgage
- Provides a lump-sum payout, like a cash-out refinance
- Typically offers a fixed interest rate
- May have a shorter timeline for closing
- May offer a lower interest rate than a personal or unsecured loan
- May offer tax-deductible interest if the funds are used to improve a primary residence
Home equity line of credit
A home equity line of credit (HELOC) is a revolving line of credit that lets you borrow against your home’s equity. A HELOC operates in two phases: the draw period, during which you can borrow various amounts and, typically, make interest-only payments, and the repayment period, when you must make payments based on the interest and principal. A HELOC:
- Also is a second mortgage, which means a second monthly payment on top of your existing mortgage
- Doesn't affect the interest rate on your existing mortgage
- Allows you to borrow money as needed during the draw period and within the terms of the agreement
- Typically offers a variable interest rate, but many offer the option of locking in fixed rates on draws
- May have a shorter timeline for closing
- May offer a lower interest rate than a personal or unsecured loan
- Interest may be tax-deductible if the funds are used to improve a primary residence
When to consider a cash-out refinance
A cash-out refinance may be a good option if you:
- Have significant home equity of at least 20% or more and have lived in your home for a number of years
- Can obtain a lower interest rate than you have on your current mortgage
- Plan to stay in your home long-term to improve the chance of reaching a break-even point to refinance, meaning savings outweigh upfront costs
- Want to consolidate high-interest debt from credit cards, plan a home renovation, or have major expenses, such as a medical bill or college tuition
FAQs
A cash-out refinance is a type of loan that replaces your existing mortgage with one that uses some of your home equity to give you a cash payout. Because your mortgage balance will be higher, your monthly payment will also could be higher.
Depending on your qualifications (such as credit history, debt-to-income ratio, the home's appraised value), lenders typically allow you to borrow up to 80% of your home’s value.
If, for example, your home is worth $400,000 you might be able to borrow up to 80% of that, or $320,000. Let's also say that you have $200,000 remaining on the mortgage, which gives you $200,000 in equity.
You could decide to get a cash-out refinance mortgage of $300,000, pay off the $200,000 on the existing mortgage, and have about $100,000 available in cash. With that new $300,000 mortgage, you would still have $100,000 in equity on your $400,000 home.
Yes. The closing costs for a cash-out refinance are similar to those of a first mortgage. These may include appraisal fees, attorney's fees, title insurance, origination fees and more. Be sure to get a breakdown of closing costs before signing on the dotted line. Expect closing costs to eat up 2% to 5% of your final payout.
Related Articles
Learn about what to expect with the mortgage and home loan lending process starting with preparing for the application process all the way through closing.
Learn more about mortgage refinance options with TD Bank. Explore why it may be a good option, get a rate quote and see how to get started.
Shopping for a mortgage is crucial to the homebuying process. Compare non-conventional vs. conventional loans, learn some key mortgage terms and more.