Cash-Out Refinance: How It Works + Pros and Cons

What is a cash-out refinance?

A cash-out refinance is a type of mortgage loan. Cash-out refinancing replaces an old mortgage with a new one for a higher amount than what you currently owe. The difference between the new loan amount and the remaining mortgage balance is paid to the homeowner in cash. The homeowners can use these funds for anything, including home renovations. Once funds are received, you're responsible for paying back the new loan under the refinanced rate and terms.

When you get a cash-out refinance, note that:

• You will likely give up equity in your house.
• You have to pay for closing costs and a home appraisal.
• It takes up to five days to get the cash after closing.
• Your current loan term could change.

» RELATED: How often can you refinance your home?

How does cash-out refinancing work?

Cash-out refinancing starts with an application process similar to the one for the original home loan. The lender considers your credit score, finances and property value, and you’ll need to provide W-2s or proof of income. A home appraisal is also typically part of the process.

Once your application is approved, it typically takes 30 to 60 days to close on the refinance loan, which replaces your existing mortgage with a new mortgage for a higher amount. Just like a traditional mortgage, a cash-out refinance has closing costs.

It takes
30 to 60 days
to close on a refinance loan.

Some lenders let borrowers roll those costs into the new loan, while others require payment upfront at closing. When you close on a cash-out refinance loan, the lender pays off the old mortgage and gives you the difference in cash, typically by check or electronic funds transfer (EFT). You then start making monthly payments on the new mortgage.

Before you apply for a cash-out refinance, you should know how much equity you have built up in your home (that is, the difference between what the home is worth and what you still owe on the mortgage). Generally, you need at least 20% equity in your home in order to qualify for a cash-out refinance.

You should also determine how much cash you are looking for and research each lender’s minimum credit score and debt-to-income ratio requirements and the closing costs associated with refinancing.

Cash-out refinance example

Here’s an example of how cash-out refinancing works: You originally financed a home purchase with a $300,000 mortgage. Today, your mortgage loan balance is $200,000.

Property values have increased since you first bought the house, and your home is now worth $325,000. Your equity in the home is $125,000.

If you were to do a cash-out refinance, you could take out a new loan for as much as 80% of the home’s current value, which is $260,000. If you did this, at closing you would receive the difference between the new loan and the old balance in cash: $60,000. Your equity would also drop from 38% to 20%.

» MORE: What is a no closing cost refinance?

Reasons to consider refinancing

It’s true that you can use cash-out refi funds for just about anything. Still, most of the people we talk to do it for one of the following reasons:

Cash-out refinancing pros and cons

If you have home equity and need cash when mortgage rates are low, a cash-out refinance could be an affordable way to borrow a large amount of money at a lower rate than with a personal loan. However, be aware that there are closing costs, and it’s important to recognize that you lose some of the equity you've built in your home with a cash-out refinance.

Alternatives to a cash-out refinance

If a cash-out refinance isn't the best fit for your financial situation, consider these alternatives:

• Home equity loan: A home equity loan allows you to borrow against your home's equity and receive a lump sum. Unlike a cash-out refinance, this does not replace your existing mortgage but adds a second loan with its own repayment schedule.
• Home equity line of credit (HELOC): A HELOC functions like a credit card, allowing you to borrow money as needed up to a certain limit, with variable interest rates. This option can be more flexible than a cash-out refinance.
• Personal loan: If you don’t have enough home equity or don’t want to use your home as collateral, a personal loan might be a viable alternative. However, these often come with higher interest rates than mortgage-based options.
• Reverse mortgage: A reverse mortgage lets older homeowners tap into their home equity without monthly payments, but it can reduce the home's value for heirs.

Each alternative comes with its own advantages and drawbacks, so consider factors such as interest rates, repayment terms and eligibility requirements when deciding which option is best for your financial situation.

FAQ

Is a cash-out refinance right for you?

There are many reasons a homeowner might consider tapping into their home equity and getting a cash-out refinance. The funds might go toward making home improvements, funding education or paying down credit card debt. If you need to borrow a large amount of money, a cash-out refinance is often a less expensive option than other types of loans.

However, there are downsides, such as closing costs, loss of home equity and restarting mortgage payments. Weigh these pros and cons carefully. If you decide a cash-out refinance mortgage is right for you, compare offers from several lenders to find the most favorable terms.