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What is a cash-out refinance?

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

Cash-out refinancing replaces an old mortgage with a new one for a higher amount than what is still owed. 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, homeowners are responsible for paying back the new loan under the refinanced rate and terms.

How does cash-out refinancing work?

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

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

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

Lenders often allow borrowers to 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. Then, you make 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. Let’s say 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.

Cash-out refinancing pros and cons

If mortgage rates are currently low and you need cash, a cash-out refinance could be an affordable way to borrow a large amount of cash at a lower rate than with a personal loan. However, be aware of fees and closing costs that can increase your loan amount or that are due upfront at closing. Also, it’s important to recognize that with a cash-out refinance, you lose some of the equity you’ve built in your home.

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
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.
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 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%.

Bottom line

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 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 is right for you, compare offers from various 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.