How It Works and When to Get One

How It Works and When to Get One

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If you need money for home improvements, paying down debt, or financing other major expenses, you could consider tapping into your home’s equity with a cash-out refinance.

With a cash-out refinance, your existing mortgage is paid off and replaced by a new loan with a higher loan amount than what you owe on your home. You get the extra amount, minus any closing costs, as a lump sum payment to use as you wish.

Here’s what you should know about cash-out refinancing:

What is cash-out refinancing and how does it work?

Cash-out refinancing lets you use the equity in your home (the difference between how much your home is worth and how much you owe on your mortgage) to take out a larger mortgage.

The new mortgage pays off your old mortgage, then you get the difference between the two, minus closing costs, as cash. Like traditional mortgage refinancing, your new loan will most likely have different terms than your old one.

Example: Let’s say you have a mortgage balance of $150,000 and you wanted $30,000 to replace the roof on your house. You could tap into a portion of your home’s equity by applying for a cash-out refinance for $180,000 — $30,000 for the roof repair and $150,000 to cover the current mortgage balance.

The lender would pay off your current mortgage and then issue you the remaining $30,000 to use for the repairs, minus closing costs and fees. So, keep in mind, if you need the full $30,000 even after costs and fees, you should aim to borrow a little more to cover them.

If you decide that cash-out refinancing is right for you, be sure to consider as many lenders as possible to find the best deal. Credible Operations, Inc. makes this easy — you can compare multiple lenders and see prequalified rates in as little as three minutes.

Get the cash you need and the rate you deserve

  • Compare lenders
  • Get cash out to pay off high-interest debt
  • Prequalify in just 3 minutes

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Learn More: How to Refinance Your Mortgage

Benefits and risks of cash-out refinancing

Before refinancing your loan, make sure you consider the advantages and disadvantages of cash-out refinancing.

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Benefits

  • Low interest rate: Cash-out refinances are secured debt with your home acting as collateral. They have lower interest rates than credit cards or personal loans, which can make them a cost-effective option for financing projects like home renovations.
  • Larger loan amount: Depending on how much equity you have in your home, you might be able to get a larger amount of cash than you could with alternatives like a personal loan.
  • Savings on high-interest debt: If you use cash-out refinancing to consolidate high-interest debt (like credit card debt), you can pay off your balances sooner and possibly save thousands of dollars thanks to a lower interest rate.
  • Longer repayment term: Because a cash-out refinance is essentially a new mortgage, you’ll have 15 to 30 years to repay it. With a longer repayment term, you’ll have more affordable monthly payments than you would with a credit card or personal loan, which usually have shorter terms.

Learn More: When to Refinance a Mortgage

Drawbacks

  • Foreclosure risk: Your home serves as collateral with cash-out refinancing. If you fall behind on your loan payments, the bank can foreclose on your house, meaning you could lose your home.
  • Closing costs and fees: Just like when you bought your home, you’ll have to pay closing costs and fees. This includes appraisal fees, credit report fees, and title fees, adding thousands of dollars to your loan costs. You might be able to roll these costs into your loan amount, but keep in mind that you could end up paying more in interest this way.
  • Lengthy application and approval process: When you apply for cash-out refinancing, you’ll have to go through the mortgage approval process. This can take several days or even weeks, so if you need the money right away, you might be better off with another financing option.
  • Lending requirements: To qualify for cash-out refinancing, you’ll have to meet the lender’s mortgage requirements. Typically, you’ll need fair to good credit — usually a score of at least 620. You’ll also need to have a debt-to-income ratio of 50% or less, plus a sizable amount of equity in your home.

If you decide that a cash-out refinance is right for you, take the time to shop around and compare lenders to find the right loan for you. Credible Operations, Inc. can help you do this — and you only have to fill out a single form.

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Alternatives to cash-out refinancing

If you decide that a cash-out refinance isn’t right for you, you have other financing options.

Personal loan

A personal loan is unsecured, meaning it doesn’t require any collateral. You can typically borrow anywhere from $1,000 to $100,000, depending on the lender and your credit history. Personal loans generally come with repayment terms ranging from three to seven years.

Limited cash-out refinancing

Like a cash-out refinance, limited cash-out refinancing lets you access some of your home equity. But it also comes with some limitations on how you can use the money.

Limited cash-out refinancing can usually be used only for one of the following situations:

  • Paying for the closing costs and fees of refinancing your mortgage
  • Repaying a Property Assessed Clean Energy (PACE) loan or a loan you took out for other energy-related home improvements
  • Buying out a co-owner
  • Converting a construction loan
  • Consolidating a first and second mortgage into a new, single loan
  • Paying off a Home Equity Line of Credit (HELOC)

Home equity loan

With a home equity loan, you can access the equity you’ve built in your home by taking out a second mortgage. Instead of having a line of credit, you’ll get a one-time, lump-sum payment.

Home equity loans typically come with a fixed interest rate, which means you can lock in a set payment amount for the life of the loan. Also keep in mind that because a home equity loan is a second mortgage, interest rates might be slightly higher than for a new first mortgage.

Home equity line of credit

A home equity line of credit (HELOC) is another way to access the equity in your home by using your home as collateral. Rather than taking out a lump sum, a HELOC lets you repeatedly tap into and pay off the funds like you would with a credit card. Keep in mind that there’s usually a minimum draw requirement, though.

With a HELOC, you’ll typically have a variable interest rate. This means the rate will go up and down along with an index (like the prime rate or LIBOR).

Scenario Consider this financing option
Home renovations Cash-out refinancing
Debt consolidation Cash-out refinancing
Education expenses Home equity loan
Short-term cash needs Personal loan
Recurring cash needs HELOC
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Frequently asked questions

Closing costs are typically 2% to 5% of the loan amount. For example, on a typical $180,000 cash-out refinancing loan, you’d have to pay $3,600 to $9,000 in closing costs.

Some lenders might allow you to roll these costs into your loan amount so you can repay them along with the rest of the loan.

Most lenders require you to retain at least 20% equity in your home, so the most you can get is 80% of your home’s total value, minus whatever you still owe on your mortgage.

For example, if you have a home worth $300,000 and owe $100,000 on your mortgage, you have $200,000 in equity. If that’s the case, the maximum you can borrow with a cash-out refinance loan is $240,000 — $100,000 to pay off your existing loan plus $140,000 in cash out.

To qualify for cash-out refinancing, you need to have at least the following:

  • A credit score of at least 620
  • A debt-to-income ratio under 50%
  • Enough equity in your home that you can retain 20% equity after the cash-out refinance

Because the money you take out with cash-out refinancing is a loan, the IRS doesn’t view it as income. This means you don’t have to report it when you file your taxes. However, doing so might get you a beneficial tax deduction.

Some, or possibly all, of the interest you pay on your mortgage might be deductible. Speak to a tax professional to understand your mortgage interest tax deduction options.

Be sure to shop around and compare rates with multiple lenders if you decide to go with a cash-out refinance. You can do this easily with Credible Operations, Inc. — and you’ll be able to see your prequalified rates in only three minutes.

Get the cash you need and the rate you deserve

  • Compare lenders
  • Get cash out to pay off high-interest debt
  • Prequalify in just 3 minutes

Find My Loan
No annoying calls or emails from lenders!

About the author

Kat Tretina

Kat Tretina is a contributor to Credible who covers everything from student loans to personal loans to mortgages. Her work has appeared in publications like the Huffington Post, Money Magazine, MarketWatch, Business Insider, and more.

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