Refinancing your mortgage involves trading in your old mortgage for a new mortgage, ideally with a better rate and terms. A cash-out refinance is a type of refinance where your new loan is greater in value than what you owe on the old loan – allowing you to “cash out” the difference. A cash-out refi can be used for any purpose, e.g. paying off debts, making home improvements, covering a large expense such as medical bills or tuition fees, or putting money aside for emergencies.
Cash-out refinancing works by borrowing more than the balance on your old mortgage. The money left over after covering your existing mortgage is paid to you at closing – minus closing costs of around 2-5% of your new loan amount. The maximum loan-to-value (LTV) ratio is typically 80%, meaning you can borrow up to 80% of the current appraised value of your home.
Here’s an example of how a cash-out refi works:
{"line":"Current home value: $400,000 "}
{"line":"Current mortgage balance: $200,000"}
{"line":"Maximum loan amount: $320,000"}
{"line":"Cash-out amount: $120,000 minus closing costs"}
Of course, the above is just an example; you can apply for less than the maximum loan amount if you want. However, be warned: once your cash-out refinance closes, you can’t apply for more cash – unless you’re willing to refinance for a second time and pay thousands of dollars in closing costs all over again.
Like with a first mortgage, you can roll your closing costs into your monthly payments so you don’t have to pay thousands of dollars upfront. However, you’ll have to pay interest on those closing costs – meaning you’ll pay more to your lender over the life of your new loan.
As a general rule, refinance cash-out rates tend to be around 1/8 to 1/4 of a point (0.125% - 0.25%) higher than on regular refinances. But even so, now is a good time to get a cash-out refinance due to the record low interest rates that have been around since Covid-19 hit in early 2020.
Let’s say you can get a 30-year fixed-rate refinance at a 3.125% interest rate or a 15-year fixed-rate refinance at 2.375% (source: Credible, November 2021). The best cash-out refinance rates would be around 3.250% for a 30-year fixed-rate cash-out refi or 2.500% for a 15-year fixed-rate cash-out refi. In other words, current refi cash-out rates are far better than what was on offer to past generations.
As mortgage data specialist Black Knight has noted, cash-outs now make up the dominant share of refis as borrowers look to cash in on record low interest rates. The combined value of all tappable equity – the amount available to American homeowners with mortgages to borrow against which still maintain at least 20% equity in their homes – now stands at a record $9.1 trillion. More than half of all tappable equity is held by homeowners with current mortgage rates of 3.5% or more – who could likely improve or keep their rate steady by cash-out refinancing. In fact, almost all recent cash-outs have resulted in rate reductions – with around 40% of cash-out refis resulting in a rate reduction of 1.50% or more.
Applying for a home refinance with cash out is virtually the same as applying for a regular rate-and-term refinance, the only real difference being that you receive a certain amount of cash at the end of the process.
When assessing your cash-out refinance application, the main things a lender will take into account are your:
{"line":"Credit score – the minimum is usually 620, although the best rates are reserved for borrowers with excellent credit of 760 or more;"}
{"line":"Loan to value, your new loan amount divided by the current appraised value of your home – the maximum is typically 80%; and"}
{"line":"Debt-to-income ratio, the monthly payment on your refinance mortgage and other loans divided by your monthly household income – the maximum is usually 45-50%."}
If interest rates have fallen or your personal credit score has strengthened since you took out your first mortgage, then a refinance can lower the cost of your mortgage and save you money. If you want a home refinance but not a home refinance with cash out, then the best product for you is a regular rate-and-term refinance.
{"line":"Rate-and-term refinance – a regular refinance that replaces your old mortgage with a new mortgage, ideally with a better rate and terms. There is no cash-out component to a rate-and-term refinance."}
If you’re looking to tap into your home equity but don’t see the need to refinance your mortgage, there are a number of alternatives:
{"line":"Home equity loan – A fixed-rate, closed-end loan where the borrower uses their home equity as collateral. The loan is paid to the borrower in a lump sum and the borrower must pay back that sum, plus a fixed annual interest rate, within the pre-agreed repayment term. Repayment terms range from 5-30 years. Like a mortgage or mortgage refinance, a home equity loan creates a lien on the borrower’s property, giving the lender the right to foreclose the property if the borrower defaults on payments."}
{"line":"Home equity loan (HELOC) – An alternative type of home equity loan product with an open-end, revolving line of credit and adjustable interest rate. The borrower may draw funds at any time, provided they don’t exceed the approved credit limit. The borrower only pays principal and interest on the funds drawn. HELOCs usually allow up to 10 years to withdraw funds and maximum 20 years to repay. Like a refinance or home equity loan, a HELOC creates a lien on your property."}
{"line":"Home equity investment – A newish product offered by a handful of fintech companies, a home equity investment pays you in cash for a right to share in the proceeds from the future sale of your home. The main benefit is there’s no lien on your property. The main drawback is it could end up costing you a lot more than a cash-out refinance, home equity loan, or HELOC."}
Gone are the days when you had to walk into a physical branch to apply for a cash-out mortgage refinance. These days, the best mortgage lenders let you apply for a home refinance with cash out online. If saving time and money on your cash-out refinance application is important to you, then read our reviews of the top digital mortgage lenders.