As home prices soar, you may wonder how to tap your equity without selling. A cash-out refinance lets you convert equity into cash that you can use to cover a bill, pay for home renovations, or consolidate high-interest debt.
Let’s explore what a cash-out refinance is, how to qualify, and the advantages and disadvantages of using one.
If you’re thinking about doing a cash-out refinance, you can easily using Credible.
A is a type of mortgage refinance that lets you change the terms of your loan while taking out cash from the equity you’ve built in your home.
The amount you borrow from equity, which is the difference between what you owe on your home and its current market value, is repaid with the rest of your mortgage. Conventional loans and government-backed FHA and VA loans offer cash-out refinance options with different eligibility requirements.
With , you take out a new mortgage loan with a higher amount and use it to pay off your old loan. You can then keep the difference between the new loan amount and the previous loan balance.
Like other mortgage refinances, cash-out refinances typically come with closing costs, such as appraisal fees and origination fees. These fees are taken from the cash you draw, reducing the amount you actually get in hand.
How much you can cash out with a refinance depends on your financial situation and the equity you have in your home. The maximum you can borrow with a cash-out refinance is typically 80% of your home’s value, which means you must maintain 20% equity after the refinance.
Let’s say your home’s value is $400,000. The maximum you may be able to borrow against your home is $320,000.
An exception to this rule is the VA cash-out refinance loan, which lets qualifying veterans, active-duty service members, Reserve and National Guard members, and eligible spouses finance up to 100% of their home’s value. So with a home value of $400,000 and a loan balance of $300,000, you could cash out up to $100,000.
Requirements for cash-out refinances can vary from one lender to the next. But some general cash-out include:
- Credit score — You may need a credit score of 620 or above to do a cash-out refinance with a conventional loan, but lenders may accept a lower score for government-backed loans.
- Debt-to-income ratio — Your DTI ratio is your monthly debt payments divided by your gross monthly income. Lenders typically want to see that less than 50% of your gross income goes to debt payments each month. But a DTI of 45% or lower could give you a better shot at getting approved.
- Loan-to-value ratio — To calculate your LTV ratio, divide the amount you owe on your loan by your home’s value, then multiply that number by 100. The maximum LTV for a cash-out refinance is often 80%, but you could have an LTV of as much as 100% with a VA cash-out refinance loan.
Credible lets you from various lenders, and it won’t affect your credit.
If you’re interested in a cash-out refi, you’ll generally need to follow these steps:
- Determine how much you need to borrow. Think about your financial obligations. Do you need money to consolidate high-interest credit card debt, pay college tuition, or give your bathroom a much-needed renovation? Figure out how much cash you need to get the job done.
- Calculate your equity. Subtract your loan balance from your home’s value to calculate your equity. If you pull your home’s value from a real estate website for this calculation, keep in mind that it’s just an estimate.
- Shop around. Compare the terms different lenders offer. Consider the interest rate, monthly payment, and overall cost of refinancing to see what loan will offer you the best deal. Prequalify with a few lenders to get a better idea of the terms lenders may offer you.
- Apply for the loan. Once you select a lender, complete the application. You may need to provide bank statements and other financial documents to prove you have enough income to keep up with loan payments.
- Close on the loan. If your loan gets a stamp of approval, you’ll sign the loan documents during the loan closing.
- Receive your cash. You may not receive your funds from the cash-out refinance right away. Instead, you may have to wait several days to a week after closing to get your cash.
Weighing the can help you decide whether it’s the right move for you. Consider these benefits and drawbacks:
- You can tap into home equity without selling. A cash-out refinance lets you pull from equity to meet a pressing financial need, like paying medical bills or making home improvements.
- You might lock in a better interest rate. Refinancing your loan could lower your interest rate or move you from an adjustable-rate mortgage to a fixed-rate mortgage. If you have better credit now than when you originally applied for the loan, you could potentially refinance to a lower rate and take advantage of interest savings.
- You may qualify for a tax deduction. If you use the cash-out refinance to make significant improvements to your home, mortgage points may qualify for a tax deduction, which could save you some money at tax time.
- Refinancing to a larger loan can increase your monthly payment. A long-term hike in your monthly mortgage payment could mean you need to make budget cuts in other areas.
- Refinancing could stretch out your loan repayment timeline. Even if the interest rate on your mortgage is low, refinancing your loan to a longer repayment term could cost you more, since you’ll be paying more interest over a longer period.
- You’ll pay closing costs. If you only need to borrow a small amount, a cash-out refinance may not be as cost-effective because the closing costs for a large loan can be expensive. These closing costs — which typically range from 2% to 5% of the loan amount — are taken out of your loan funds before you receive your money.
A cash-out refinance could make sense if you want to borrow a large sum and have lived in your home long enough to have equity to draw from. Cashing out to make home repairs could also be a good option if you want to claim the potential tax deduction and help increase the value of your home before selling it.
On the other hand, a cash-out refinance might not make sense when you need to borrow just a few thousand dollars or less, since the refinance closing costs could cost more than what you actually borrow.
While it may be convenient to draw from your equity, it’s also important to consider that you could end up underwater on the home if the housing market takes a downturn after you cash out. In this scenario, you’d owe more on the home than it’s worth.
If you put less than 20% down when you bought the home and have only lived there for a few years, chances are you may not have enough equity to take cash out anyway, unless your home has seen a huge leap in value since you purchased it.
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If you need money to make a major purchase, consolidate debt, or pay a bill, you may want to consider these other financing options:
Home equity loan
A is another way to borrow from home equity in an installment loan, but it’s a second mortgage in addition to your current mortgage, and it uses your home as collateral. Most home equity loans have a fixed interest rate, and repayment terms can range from five to 30 years.
You may pay closing costs to process the loan, but your lender may be willing to pay for some or all of these costs — just keep in mind that you may be charged a higher interest rate in exchange. If you need to borrow a smaller sum, a home equity loan could be a better option than a cash-out refinance.
Home equity line of credit (HELOC)
A , works more like a credit card. The lender offers you a line of credit backed by your home that you can use and pay back as needed. Because you use your home as collateral, you can usually get a lower interest rate with a HELOC.
HELOCs typically come with variable interest rates, and they may have a draw period where you can use the credit line, followed by a repayment period when you have to pay the money back. A benefit of HELOCs is that you only pay interest on the money you borrow, not the whole credit line. HELOCs could be a better option than a cash-out refinance if you need to borrow money here and there rather than in one lump sum.
WHAT IS A HOME EQUITY LINE OF CREDIT AND HOW DOES IT WORK?
Unsecured personal loans may offer low interest rates and fixed payments to borrowers with good to excellent credit. Personal loans are also flexible, with loan terms commonly ranging from one to seven years.
With an unsecured loan, you also don’t have to pledge collateral like your home or car to back the loan, which minimizes your risk. Plus, many lenders let you complete the entire process — from application to approval — completely online.
Before taking out a cash-out refinance loan, check out the answers to some of the most common questions about cash-out refinances.
How long does it take to get the money from a cash-out refinance?
While the exact time frame for going through the mortgage refinance can vary, it typically takes up to a few days after closing to get your cash. If you need money quickly, a personal loan could be a faster alternative, since some lenders offer same-day funding.
How does a cash-out refinance affect your credit score?
Like any other refinance, a cash-out refinance typically involves a credit check performed by the lender to review your credit. The hard credit check could result in a temporary decrease in your score. Increasing your loan amount will also increase how much debt you owe overall, which could also affect your score. Since this raises your credit utilization, which accounts for 30% of your FICO Score, your score could drop.
How does a cash-out refinance affect your taxes?
Money from a cash-out refinance isn’t taxable income since it’s an amount that you’re borrowing, and not a source of income. You also may be able to deduct the mortgage points from your refinanced loan if you use the funds to make improvements to your home. goes into detail about the conditions for this deduction.