How Does a Cash-Out Refinance Work: Cash-Out Refinance Explained

March 26, 2021 | 3 min read | Refinance, The mortgage process

Now is a great time to refinance as interest rates remain at all-time lows, and many homeowners are sitting on untapped equity. If you have equity in your home and are looking for extra cash-on-hand for upcoming expenses, you may benefit from a cash-out refinance. 

What is a Cash-Out Refinance?

A cash-out refinance is when you leverage the equity* in your home to replace your existing mortgage with a higher loan amount than what you currently owe. The difference between the loan amounts is cash available to you. 

*Equity is the difference between the amount owed on your mortgage and the market value of your home. Equity may increase over time as you pay down the mortgage principal, or there’s an increase in the appraised property value.

How Does a Cash-Out Refinance Work?

Let’s say your home is worth $100,000 and your current mortgage balance is $50,000. That means you have $50,000 of equity in your home that you can tap-into as cash. If you apply for a cash-out refinance with a loan amount of $75,000, you will receive $25,000 in cash ($75,000 – $50,000).  

Basic Guidelines for a Cash-Out Refinance

Loan-to-value limits
Typically, mortgage companies will only allow a loan-to-value (LTV) of 80% for a cash-out refinance; however, the limits may vary. 

Must have equity in your home
To leverage the equity in your home and take cash-out, you must have at least 20% equity in your home. Thus, if your original down payment was 10% of the home’s value, then you will have to wait until you have made enough mortgage payments to reach 20% equity before you qualify for a cash-out refinance.

Have a good credit score
Having a good credit score is an essential component in helping mortgage companies evaluate your ability to handle debts. If you have a higher credit score, you may qualify for better LTV limits and interest rates.

Have a low debt-to-income ratio
Your debt-to-income (DTI) ratio signifies how much of your monthly income is allocated towards monthly debts. A cash-out refinance provides you with a higher loan amount than before, which may slightly increase your DTI ratio. 

What are the Benefits of a Cash-Out Refinance?

Here are a few ways in which you can utilize the cash proceeds from the refinance:

Consolidate high-interest debt
This is a good option for those with high-interest debt, such as credit card bills. You can put the cash towards the high-interest-bearing balance and then consolidate the remaining debt into a single loan with lower interest. Paying off loans with high-interest and substantial balances may help you save money in the long-run. Additionally, the faster you pay off debt, the more money you will have for future savings!

Pay off student loan debt
Although federal student loans are not accruing interest and can be put on hold right now, you can use the cash to pay down your student loan balance to help you work towards a debt-free life faster.

Put More Money into Retirement for Long-Term Savings
This is a good option for those who want to focus on long-term savings. Maybe you haven’t been able to save as much recently because of unexpected expenses but want to boost your retirement account and focus on long-term savings. Remember, it’s never too early to start saving!

Purchase an Investment Property 
For savvy buyers, now may be a great time to expand upon your investment portfolio. We are in a buyer’s market, and mortgage rates remain at all-time lows. Use the funds from the cash-out refinance to invest in a second home for your family or an investment property to generate additional revenue. 

Pay for Home Improvements & Repairs
You may be able to use the cash to pay for home renovations and repairs you’ve always wanted to accomplish. This may be an excellent option for those looking to sell their home soon, as home improvements can increase the house’s value.

HELOC vs. Cash-Out Refinance

The main difference between a HELOC and a cash-out refinance is that a HELOC is an additional mortgage, whereas a cash-out refinance replaces your current mortgage. A HELOC will require other monthly payments in addition to your monthly mortgage payments. Additionally, HELOCs typically have higher interest rates than cash-out refinances. 

Some may want a HELOC over a cash-out refinance to take out cash as needed instead of getting a lump sum after closing. However, we recommend speaking with one of our mortgage specialists to determine if a HELOC or cash-out refinance is best for you.

To learn more about cash-out refinancing or to get started, contact us today!