With recent increases in home values across most of the country, many homeowners are sitting on a lot of home equity. But what if you want to access some of that money to make home improvements or pay off high-interest debt? It’s possible to withdraw cash from your home equity if you qualify for a cash-out refinance loan.
What is a cash-out refinance?
A cash-out refinance replaces your existing home loan with a new, larger loan. The difference between the two loans is the amount of cash you withdraw from the total equity in your home. There are no restrictions on the use of the withdrawn cash.
When you finance a home purchase, a portion of your monthly mortgage payment goes towards paying off your principal — the amount of money you originally borrowed. The rest of your monthly payment is made up of interest, home insurance and taxes. With each monthly principal payment you make, you own a bit more of your home outright, meaning you gain equity over time. Your equity also grows when your property value increases.
The amount of equity you have in your home is an important factor in how much cash you’ll be able to access with a cash-out refinance.
Cash-out refinance example
If you bought a $300,000 house and still owe $200,000 on the current mortgage, you’ve built up $100,000 in equity (assuming the current market value of your home is also $300,000). Now, let’s say you want to pay for a $30,000 home renovation. With a cash-out refinance, you could get a new loan with a principal balance of $230,000–this total includes the $200,000 you still owe on your home plus the $30,000 you’re going to take out in cash. Note: this example does not include applicable closing costs.
Cash-out refinance closing costs
Cash-out refinance closing costs range between 2-6% of the total loan amount and are deducted from your “cash-out” at closing. Cash-out closing costs are typically higher than other refinance options because rates are higher and many borrowers opt to buy down their rate with mortgage points. These optional mortgage points increase your closing costs. because the underwriting process is more complex. Your specific cash-out refinance closing costs are based on the size of your loan, length of term and credit score.
Your loan type also has an effect on your cash-out closing costs. For a cash-out refinancing on a conventional loan, there’s typically a 3% fee cap, subject to the ability to pay/qualified mortgage rule (abbreviated ATR/QM). FHA and VA cash-out refinances can have additional fees that may bring your costs closer to 6%.
In comparison, closing costs for refinance options like rate-and-term or cash-in typically range from 2-5% of the loan amount. On a national level, average refinance closing costs are $5,000, according to Freddie Mac, but it varies significantly by state, county and home value.
To limit your out-of-pocket costs, shop for a lender with lower costs and a competitive rate. Some cash-out refinance lenders offer “no cost” refinances, which really means the loan you are getting adds the closing costs to the principal balance on the loan, or has a higher interest rate.
How much can you take out on a cash-out refinance?
Most lenders require you to retain 20% equity in your house after the cash-out is complete. This is called having a loan-to-value (LTV) ratio of 80%. Maintaining 20% ownership of the property ensures you can avoid having to pay private mortgage insurance (PMI). It can also help to prevent you from being underwater (owing more than your home is worth) if market conditions change.
Since 2008, cash-out refinancing has been capped at 80% LTV. However, homeowners who qualify for VA loans have more options; there’s a VA cash-out loan that allows for 100% equity withdrawal. Keep in mind, you’ll likely pay a higher rate and monthly PMI, so it’s important to weigh your decision carefully.
In the example above, where you own a home worth $300,000, the typical 80% LTV requirement means you must retain $60,000 in equity. Your current mortgage balance and the market value of your home dictates the amount of cash you can withdraw. The table below details the total walkaway cash you could get with cash-out refinance at varied mortgage balances, assuming 3% closing costs.
|Appraised home value||Current loan balance||Possible cash-out maximum (80% of home value ($240,000) minus loan balance)||Likely walk-away cash (minus 3% closing costs)|
|$300,000||$250,000||$0 (you must have at least 20% equity)||$0|
Am I eligible for a cash-out refinance?
Cash-out refinancing is available to homeowners with both conventional and government-backed mortgages. Above and beyond the equity requirements, individual lenders or loan types may have specific criteria, like minimum credit scores or a requirement to have owned the home for a minimum amount of time — for conventional and VA loans, it’s six months. For FHA loans, it’s one year. There are some exceptions to this rule, in the case of death of a homeowner, inheritance, or legal divorce or separation.
Should you do a cash-out refinance?
If you need cash, have enough equity, and interest rates are favorable, a cash-out refinance might be the right solution. Crunch the numbers in our refinance calculator.
Compared to high-interest credit cards, it may be more affordable to access the cash you need with a cash-out refinance. Plus, if current interest rates are lower than your existing rate, you can both access the cash you need and lock in a lower interest rate over the life of the loan. This becomes an even more popular option during uncertain times.
Alternatives to a cash-out refinance
When you’re looking to leverage the equity in your home, a cash-out refinance mortgage isn’t your only option. Consider these alternatives.
HELOC vs a cash-out refinance
Like a cash-out refinance, a home equity line of credit (HELOC) allows you to pull cash out from your home’s equity. However, instead of it being part of your mortgage, it’s a revolving line of credit, up to a defined maximum amount, secured by your home. Interest rates are usually variable, and you’ll only pay interest on the amount you use. Fees range from 2-5% of the total line of credit, and homeowners can typically make interest-only payments during the initial draw period.
Home equity loan vs a cash-out refinance
Also known as a second mortgage, a home equity loan gives you a lump sum of money, secured by the equity in your home and repaid on a fixed schedule. That means that every month, you’ll make your existing mortgage payment and a second, separate payment for the home equity loan. In comparison, a cash-out refinance originates a new, single mortgage.
How does a cash-out refinance work?
A cash-out refinance follows roughly the same process as traditional refinancing. You’ll work with a bank, lender or mortgage broker to identify the best rate and terms. You’ll complete a loan application and credit check. Once you are approved, an appraisal is usually required. After the appraisal confirms you have enough equity in your home to proceed, you’ll schedule a closing. Upon closing, you’ll receive the funds from your cash out and will be able to use them how you’d like.
Here’s a little more detail on each step of the process.
1. Confirm you meet the cash-out refinance qualifications
The first step is ensuring you qualify for a cash-out refinance. Lenders each have their own cash-out refinance requirements, but there are some general guidelines they typically look for. The minimum cash-out refinance credit score for a conventional loan is 620. It’s 580 for FHA and VA loans. Some lenders will work with borrowers with lower scores.
You’ll also need a debt-to-income (DTI) ratio of less than 50%. And, as previously mentioned, you’ll need enough equity in your home that you’ll still have 20% after your new loan closes. You’ll also need to meet the minimum seasoning requirement for length of home ownership, which is the amount of time you’ve lived in your home. It’s usually a minimum of six to 12 months.
At-a-glance cash-out refinance qualifications:
- 620 credit score
- 50% DTI
- More than 80% LTV before the refinance
- Ownership of 6-12 months, depending on loan type
2. Determine the cash-out amount
Allow your lender to help inform your decision about the amount of equity you should pull from your house. Beyond lender input, be realistic about how much cash you need. Remember, you’ll be paying interest on the total amount you receive, so don’t take out more money than you need.
3. Shop refinance rates
The higher your credit score, the lower your refinance interest rate. But if you’re withdrawing large sums, those interest rates will increase. Buying the rate down could save you substantially over the life of the loan, but these points are costly. Your bank, lender or mortgage broker can walk you through your options.
4. Formally apply for a cash-out refinance and lock your rate
Once you’re ready to move forward, it’s time to apply for your loan. This will be just like applying for your initial home loan. Your rate will be determined by your credit score and the amount you’re borrowing, and you’ll receive a detailed loan estimate, disclosures and a summary of closing costs before moving forward.
5. Complete a home appraisal
Because your cash-out refinance is dependent on your home’s equity, it’s typical for your lender to request an appraisal. There are instances where the appraisal is waived if you’re borrowing less than 70% LTV. The combination of your cash out, remaining equity and loan cannot exceed the appraised home value. Unlike a home inspection, a home appraisal focuses on your home’s value, not its condition.
6. Pay closing costs and close
At loan closing, the costs are deducted from the cash-out amount. You won’t bring cash to closing but you will sign financing documents. Once the loan is recorded and you’ve completed the 3-day waiting period, you’ll be wired the funds you’ve requested for your cash-out.
How long does a cash-out refinance take?
The timeline for a cash-out refinance ranges from one to two months depending on steps including the application process, waiting to lock the rate, completing the appraisal, underwriting, document signing, and a three-day mandatory waiting period during which the borrower can change their mind. Like other loan closing processes, the standard timeframe is 30-45 days.
Get started with your cash-out refinance
Ready to take the first step toward completing a cash-out refinance and getting the cash you need? Use our refinance calculator and compare rates from a marketplace of refinance lenders.
Frequently asked cash-out refinance questions
Do you pay back a cash-out refinance?
Unlike a home equity loan or HELOC, a cash-out refinance does not create a new line of credit or debt. Instead, you refinance your existing mortgage into a new loan that includes the cash amount you’re withdrawing, and your repayment resets at the term that you choose, generally 15 or 30 years.
What is the difference between a refinance and a cash-out refinance?
The most common mortgage refinance is a rate-and-term refinance, in which homeowners reset their mortgage rate and/or term (15-year or 30-year), typically to take advantage of lower rates. A cash-out refinance allows homeowners to withdraw some home equity as cash, while updating their mortgage rate and term.
What is a limited cash-out refinance?
A limited cash-out refinance allows homeowners to refinance at a more favorable rate and/or term, while receiving a limited amount of cash, no greater than 2% of the new loan balance or $2,000 (whichever is lower). Closing costs are rolled into the loan, making it slightly larger than your existing loan amount. With a limited cash-out refinance, you do not access your home equity. This can be advantageous for those looking to put a little cash in their pockets while refinancing — but not a great fit for those with larger funding needs.
How much money do you get from a cash-out refinance?
How much you’re able to pull out depends on how much your home is worth. Remember, you’ll need to retain 20% equity in your home, factoring in your remaining mortgage balance and the cash you take out.
How can you use a cash-out refinance?
There are no restrictions on the use of your cash after withdrawing it from your home’s equity when you use a cash-out refinance loan. You can use the funds however you’d like.