Cash-Out Refinance Guide: Definition and Advantages

A cash-out refinance is a type of mortgage refinancing that lets you access money from your home’s equity by taking out a new, higher mortgage on your home. If you have equity in your home—meaning the appraised value of your home is greater than what you owe on your current loan—you can take out a new mortgage and receive the difference between your old mortgage and the new mortgage as a lump sum. Most cash-out refinance loans will allow you to take up to eighty percent of your equity, which is called the loan-to-value ratio (LTV) without having to pay for private mortgage insurance (PMI). The only exception to this is with VA loans, which allow veterans and servicemembers to take out up to one-hundred percent of their equity.

A cash-out refinance loan is a common option for homeowners who need cash for home renovations or other home improvements, debt consolidation of high-interest loans or credit card debts, or to pay for education or other major investments. The cash can be used for any financial need or purpose, but it’s generally not recommended to use a cash-out refinance to pay off student loans or buy a new car.

Cash-out refinancing and home equity loans both allow you to turn home equity into cash, but they work differently. With cash-out refinancing, your old mortgage loan is replaced with a new mortgage with a higher loan amount, which means you still only have to pay one home mortgage. With a home equity loan, you’ll take out a second loan, separate from your primary mortgage. You’ll pay a separate interest rate on the loan term, just like a second mortgage. This means that if you were to take out a home equity loan, you would then have two separate loans.

Another mortgage refinance option similar to home equity loans is a home equity line of credit (HELOC) which is also a loan taken out on the equity of your home, but it is a revolving credit line with a preset limit that the borrower can take out money against as needed. Home equity lines of credit will typically have variable interest rates, while a cash-out refinance or a home equity loan will often be fixed rate loans.

Cash-out refinancing can have some major advantages, but it’s important to consider your personal finances, including your debt-to-income ratio, before taking out a new loan or increasing your monthly mortgage payment. It may also be helpful to discuss your options with a financial advisor.

1. 1. Receive cash: The money you receive from a cash-out refinance is yours to spend however you wish. You can use this money to upgrade your home, pay off debt, make investments, or make any other purchases you desire.
2. 2. Lower interest rates: When you perform a cash-out refinance you are creating a new loan for a higher amount. Like any type of refinancing, the new loan may have a lower mortgage interest rate than the original mortgage. Mortgage lenders may offer a lower refinance rate for borrowers to incentivize cash-out refinancing on their current mortgage balance. Your new mortgage rate may be favorable compared to a personal loan or a credit card loan, which generally come with higher interest rates.
3. 3. Improve credit score: You can use a cash-out refinance to pay off loan debt, which can help improve your credit score. Consolidating your high-interest debt into a single, lower interest loan option may also lower your monthly payments and make it easier to make each payment to build good credit, which will help in the long run when it comes to loan repayment.

While a cash-out refinance may help you consolidate debt or give you a lower interest rate than the one on your existing mortgage, a cash-out refinance loan isn’t the right choice for everyone.

1. 1. Closing costs: First-time homebuyers expect to pay closing costs when they take out their first mortgage, but did you know that you have to pay closing costs when refinancing, too? A cash-out refinance is a new mortgage, and as such will incur fees including credit report fees and appraisal fees.
2. 2. New appraisal: A cash-out refinance is dependent on your home’s value, which will determine your available equity. This means you will be required to get a new real estate appraisal on your property, which can be a time-consuming and costly process. Additionally, it’s possible that the appraised value won’t match up with what you thought your home was worth.
3. 3. Delayed payment: Taking out a cash-out refinance loan doesn’t happen overnight. It’s a slower process that involves getting a new appraisal as well as underwriting to evaluate your finances, and another waiting period once you’ve been approved. This means it’s not a great option if you need cash immediately or don’t meet the eligibility requirements.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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