What Is A Cash-Out Refinance And Can It Work For You?
If you've created equity in your home, you might wonder how to access it without selling. The good news is there is an option called a cash-out refinance. If you're wondering what a cash-out refinance is and how it works, keep reading to learn more.
What Does A Cash-Out Mortgage Refinance Mean?
A cash-out refinance loan is a form of mortgage refinance that allows homeowners to borrow a larger mortgage than they currently have. Homeowners can borrow against their home's value, keeping the difference between the new mortgage amount and what is owed on the current mortgage.
You might wonder how a cash-out refinance works. Here's a simple explanation.
Cash-out refinancing doesn't require a second lien on your property like a home equity line of credit (HELOC) or home equity loan does. Instead, you refinance your first mortgage for a larger loan amount based on the equity in your home.
Your home's equity is the difference between its current market value and the outstanding loan amount on your first mortgage. Most lenders allow homeowners to have a loan-to-value ratio (LTV) of up to 80% of their home's current market value.
When Should You Get A Cash-Out Refinance Loan?
You may stand a good chance for approval on a cash-out refinance loan if you have a qualifying credit score, a low debt-to-income ratio (DTI), and adequate equity in your home. Of course, like any loan, there are different reasons to use a cash-out refinance, but here are some of the most common reasons.
- To increase home value: Some homeowners use their home's equity for home improvements or renovations. If the renovations increase your home's value, you could earn the equity back quickly and make more profits when selling your home.
- To lower the interest rate: Depending on your interest rate when you borrowed your current mortgage and where rates are at the time you refinance, you may be eligible for lower rates on a cash-out refinance if you have improved credit or your home value increased significantly.
- To get an adjusted repayment period: If you need to change your repayment period to make it longer or shorter, you may use a cash-out refinance. This allows you to use some of your home equity while adjusting your payments to what you can afford, paying the mortgage off faster or extending your loan term for lower payments.
- To consolidate debt: If you have a lot of high-interest debt, you might consolidate with a cash-out refinance loan. You can use the equity to pay off your debts, wrapping everything into one loan and one payment. This may make it easier to keep up with your financial obligations.
What Are The Requirements For A Cash-Out Refinance?
As you learn the answer to “what is a cash-out mortgage refinance,” you’ll find that the criteria are similar to that of a standard mortgage refinance. You'll need the same documentation, but there may be some minor differences, including the following:
The amount you can borrow with cash-out refinancing depends on your home’s equity. The higher your home’s value and the lower your outstanding mortgage balance, the more equity you have.
You can borrow as much as 80% of the home's current value if you can afford the loan amount, meeting the loan program's required credit score and debt-to-income ratios. However, this may be lower than the LTV or CLTV allowed for a standard refinance.
Lenders look closely at several aspects of your credit when determining if you qualify for a cash-out refinance loan. This tells lenders what you can afford and how you handle your current liabilities. The requirements are usually stricter than those imposed on traditional refinance loans.
- Credit score: Your credit score shows your level of financial responsibility. The credit bureaus calculate it based on your payment history, outstanding credit, credit age, credit mix and new credit. Most homeowners need a credit score of at least 620 to qualify. However, FHA loans may allow a cash-out refinance on scores as low as 580.
- Credit history: Your credit history portrays how well you handle your liabilities. An on-time payment history over the last 24 months could work in your favor when applying for cash-out refinancing.
- Debt-to-income ratio (DTI): Your DTI measures your debt obligations compared to your income. Most loan programs allow up to a 50% DTI for cash-out refinancing.
Reasons To Take Advantage Of A Cash-Out Refinance
A cash-out refinance loan can have many advantages, helping homeowners reach their financial goals. Here are some reasons a cash-out refinance may be right for you.
Home Improvement And Renovations
The money you receive from your refi can help you afford home improvements or renovations. There are many benefits of improving your home, including more enjoyment for your family, but the most significant benefit is increasing your home's value, allowing you to build equity.
The 2017 Tax Cuts and Jobs Act created new interest deduction rules on refinance loans, only allowing homeowners to deduct interest paid on funds used to build, buy or repair a home. So using your cash-out refinance loan for home improvements can have multiple benefits.
Second Home Or Investment Property
If you've built up a large amount of equity in your home, you may consider a cash-out refinance to use the funds for a down payment on a second home or investment property. Real estate may help diversify your portfolio. However, it comes with risks.
There's no guarantee real estate will appreciate or that you'll be able to make money on a rental. So before using your funds for more real estate investments, consult your financial or tax advisor to ensure it's a good use of your equity.
Paying high-interest debt can drain your finances and make you feel like you'll never get out of debt. However, you may be able to consolidate your debt at a lower interest rate using your home equity in a cash-out refinance loan.
Only consider this option if you are in a good enough financial position to afford the larger mortgage payment and won't dig yourself deeper into debt by racking up balances on your now-open credit cards again.
You can use your home's equity however you want, and if you don't have an emergency fund saved, it can serve that purpose. However, since you can't access the equity in your home instantly, many homeowners withdraw the equity with a cash-out refinance loan and put the funds in an interest-bearing account to earn a return on their investment while the money remains unused.
Cash-out refinancing is an option to cover educational expenses but use this option with caution. Many students are eligible for lower interest rates on federal student loans or student loan forgiveness after graduating. Before using your home's equity to pay educational expenses, exhaust all options for federal aid and low-interest student loans.
You may consider a cash-out refinance if you want to diversify your portfolio and invest in the stock market instead of having all your money wrapped up in your real estate. However, use caution since there is a risk in investing in the stock market. Any money you invest in the stock market should be for at least 10 years to see a decent return on your investment. When making investment of other financial decisions, it’s recommended you speak to a financial advisor.
Cash-Out Refinance Loan Options
You might wonder about your loan options. There are a few, including conventional and government-backed cash-out refinancing.
Conventional Cash-Out Refinance Loans
Conventional cash-out refinance loans are traditional cash-out loans through lenders. They have the strictest cash-out refinance requirements but offer the best rates and terms. You can use this option for loan amounts up to $726,200.
Jumbo Cash-Out Refinance Loans
If your loan amount is higher than the conforming loan limits of $726,200, you will need a jumbo cash-out refinance loan. This loan allows much higher loan amounts but has stricter requirements because lenders underwrite and fund these loans without any backing from government entities.
FHA Cash-Out Refinance Loans
FHA cash-out refinance loans allow up to an 80% LTV and, like traditional FHA loans, have somewhat relaxed underwriting guidelines. In most cases, you'll need a DTI of 45% or lower and an on-time payment history for the last 12 months on your current mortgage. You must also wait until you've been in the home for at least 12 months to qualify.
VA Cash-Out Refinance Loans
If you're a veteran with a current VA loan, you may qualify to tap into your home's equity using a VA cash-out refinance. Unlike conventional loan cash-out refinances, if you have at least a 620 credit score, you can borrow up to 100% of your home's equity in a VA cash-out refinance. However, many lenders use the conforming loan limits as guidelines regarding how much you can borrow against your home in a VA cash-out refinance.
To qualify, you must have a Certificate of Eligibility (COE) and a debt-to-income ratio of 45% or less for a fixed-rate mortgage and 50% or less for an ARM.
Cash-Out Refinance: Pros And Cons
Weighing the pros and cons of cash-out refinancing is the key to making the right choice for your home.
- A lump sum of cash: You receive the equity borrowed as one lump of cash you can use how you see fit, whether for home improvements, debt consolidation or depositing it into a savings account.
- Fewer monthly payments: If you use a cash-out refinance to consolidate debt, you reduce your monthly payments. This may make it easier to manage your finances and get out of debt.
- Tax-deductible interest: If you use your home’s equity to buy, build or repair your home, you may be eligible to deduct the interest paid each year.
- Risk of foreclosure: Borrowing money from your home puts a lien on the property. If you miss too many payments, you risk losing your home.
- Closing costs: Most mortgage loans have closing costs, and cash-out refinancing is no exception. Most homeowners pay 2% – 6% of the loan amount in closing costs.
- A higher monthly payment: A higher loan amount may mean a larger monthly payment. The exact payment depends on the loan terms and interest rate when refinancing.
Alternatives To A Cash-Out Refi
A cash-out refinance isn’t the only way to tap into your home’s equity. Here are some other options.
Home Equity Loan
A home equity loan or second mortgage also taps into your home's equity but is a second lien on the property. They may have less stringent requirements yet provide similar interest rates, making it a viable option. With a second mortgage, you don't have to touch your first mortgage, which can be beneficial if you have attractive terms on your first mortgage.
Home Equity Line of Credit
A HELOC is another second mortgage, but it has the flexibility of a credit card. HELOCs have variable interest rates that may be slightly higher than traditional loans, but the flexibility may be beneficial, especially for home improvements. Rocket Mortgage® does not offer HELOCs at this time.
Personal loans are an option when you need money fast. They are unsecured loans, so you can get funded more quickly, but they often come with higher interest rates. You can use funds from a personal loan to cover an immediate expense and then a cash-out refinance to pay the loan off later.
FAQs: Cash-Out Refinance
Before choosing a cash-out refinance, consider the following frequently asked questions.
How Much Money Can I Get By Cash-Out Refinancing?
How much money you can borrow depends on your credit score, mortgage type, property type and value and loan-to-value ratio. Lenders must ensure you can comfortably afford the loan and that its parameters are within the loan's guidelines.
How Long After Cash-Out Refinancing Do I Get The Money?
Does A Cash-Out Refinance Affect My Credit Score?
A cash-out refinance is like any other loan. Taking out new credit changes your debt and credit mix, which can affect your credit score. However, any negative effects should be temporary, and you can help increase your score with on-time payments.
Can I Get A Cash-Out Refinance On A Second Home?
You may get a cash-out refinance on a second home. However, the requirements may be stricter than primary residences. This is because lenders have an increased risk of default when lending on a secondary property because it's not your primary house, so they often require higher credit scores or lower LTV limits.
What’s The Difference Between A Cash-Out Refinance And A No-Cash-Out Refinance?
A cash-out refinance is for a loan amount higher than you currently owe, and a no-cash-out refinance or rate-and-term refinance is for a loan amount no greater than your current loan balance. Most homeowners use the rate-and-term refinance to lower their interest rate or change the loan’s term.
The Bottom Line
Now that you know what a cash-out refinance is, you can determine if it's right for you. A cash-out refinance loan may help you consolidate debt, make home improvements or set up an emergency fund. If you've decided cash-out refinancing is right for you, apply for a mortgage refinance loan to see what you qualify for and how it can help your financial situation.