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Cash-out refinance: how it works + pros and cons

Profile picture of Kathryn Parkman
by Kathryn Parkman ConsumerAffairs Research Team
house sitting on top of cash

A cash-out refinance lets you tap into the equity you’ve built up from years of regular mortgage payments. In exchange for a reduction of equity, you get access to cash that you can use for whatever you want.

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.

Things to know about getting a cash-out refinance

  • 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.

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%.

Current conventional national mortgage rates

Rates are effective 09/20/2021 and are subject to change without notice. APR shown is provided by a partner of ConsumerAffairs.

ProductAPR
3.229%0.0%Get Rates

The APR shown of 3.229% is available for a 30-year fixed rate loan in the amount of $200,000 for consumers with loan-to-value of at least 80%.

2.812%0.0%Get Rates

The APR shown of 2.812% is available for a 20-year fixed rate loan in the amount of $200,000 for consumers with loan-to-value of at least 80%.

2.654%0.0%Get Rates

The APR shown of 2.654% is available for a 30-year VA fixed rate loan in the amount of $200,000 for consumers with loan-to-value of at least 80%.

2.413%0.0%Get Rates

The APR shown of 2.413% is available for a 10-year fixed rate loan in the amount of $200,000 for consumers with loan-to-value of at least 80%.

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How COVID-19 may affect refinancing

Mortgage rates went down during the coronavirus pandemic, which caused an increased demand for cash-out refinancing loans. In fact, mortgage interest rates hit a 30-year low at the beginning of 2021.

Like so many other things, refinancing a mortgage was more difficult during the pandemic. Some of the steps, such as title searches and notarizations, were delayed because of closures and restrictions on in-person meetings. Additionally, some lenders tightened their eligibility requirements, and others were unable to accommodate new clients.

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.

Pros

  • No restrictions on how funds are used
  • Tax-free cash
  • Potentially lower interest rate

Cons

  • Closing costs of 2% to 5% of mortgage
  • Loss of home equity
  • Potentially higher monthly payment

Frequently asked questions

How much cash can you take out?
The maximum total loan amount with a cash-out refinance loan is typically 80% of the home’s value, but this can vary by lender. The amount of cash you get at closing will be the difference between the new loan amount and the payoff amount of the old mortgage.
Can you use the funds for anything?
Yes, you can use the funds for pretty much anything. Borrowers sometimes use the cash to fund home renovations, pay for education costs or pay down high-interest debt.
What is the difference between cash-out refinancing and a home equity loan?
Cash-out refinancing pays off the original mortgage and starts a new one. A home equity loan keeps the old mortgage in place while opening another loan with the home as collateral. Both types of loans give you a lump sum of cash, but a home equity loan adds an additional payment and usually has a higher interest rate.

Read about the differences between a reverse mortgage, home equity loan and home equity line of credit (HELOC) for more information.

Does a cash-out refinance affect your credit score?
Yes, a cash-out refinance affects your credit score. The lender performs a hard inquiry on your credit history as part of the application process, which lowers the score by a couple of points. In addition, the closure of your old mortgage can lower your score.
How much equity do you need for a cash-out refinance?
The rule of thumb is you need 20% equity in your home to qualify for cash-out refinancing. Most lenders will not approve a cash-out refinance loan if the loan-to-value ratio is more than 80%.

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.

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Profile picture of Kathryn Parkman
by Kathryn Parkman ConsumerAffairs Research Team

As a member of the ConsumerAffairs Research Team, Kathryn Parkman believes everyone deserves easy access to accurate and comprehensive information on products and businesses before they make a purchase, which is why she spends hours researching companies and industries for ConsumerAffairs. She believes conscious consumption is everyone's responsibility and that all content deserves integrity.