What would you do with some extra cash in your pocket? Maybe you’d update your home, put the funds toward a child’s college tuition, or consider consolidating outstanding debts*. All of these are possible through a cash-out refinance. Depending on how much equity you have in your home, refinancing can be an opportunity to convert some of your equity into cash. This is known as a cash-out refinance.
What is a cash-out refinance?
A cash-out refinance replaces your current mortgage with a new loan that is for more than what you owe on your house. This type of refinance is an alternative to a home equity loan or a home equity line of credit. It involves applying for a mortgage that exceeds the balance of your existing mortgage and receiving the difference in cash.
How a cash-out refinance works
A cash-out refinance is a little more complicated than a typical refinance where you replace the existing loan with a new one for the same amount.
With a cash-out refinance, you’re receiving a portion of your home equity as a lump sum. Most lenders require you to keep 20% equity in your home, which means you can typically withdraw up to 80% of your home’s value.
Costs and fees associated with a cash-out refinance
Refinancing a mortgage does involve costs. Closing costs on a cash-out refinance vary depending on location. To avoid any surprises, you should expect to pay between 2% – 5% of your loan on closing costs when you refinance. Closing costs are paid at closing and can include the mortgage origination fee, title search fee, attorney fees, points, prepaid interest, and other mortgage-related costs.
Some lenders do offer a no-closing cost mortgage for qualified buyers, but that usually means you’ll have a higher interest rate. While this will decrease your upfront costs, the tradeoff may be a higher monthly payment or paying more interest over the life of the loan.
When should you do a cash-out refinance?
A cash-out refinance increases the amount you owe on your home loan, so you should only take a cash-out option when it makes sense. Here are some reasons why you might want to pursue a cash-out refinance.
You’re able to refinance at a lower rate
A cash-out refinance will reset the clock on your mortgage term to 15 to 30 years, depending on the term you select. Additionally, your new mortgage rate will be based on current mortgage rates. If today’s rates are lower than your original mortgage interest rate, a cash-out refinance can allow you to take advantage of the equity you’ve built while locking in a better rate.
You can afford a higher monthly payment
Because you’re borrowing from your this article equity and increasing your mortgage balance, a cash-out refinance can create a more expensive mortgage payment. For this reason, only touch your equity when you’re confident in your ability to afford a higher payment.
When you apply for mortgage refinancing, our underwriters will review your income, assets, and existing debt to determine affordability. Depending on the type of mortgage loan, your house payment should not exceed 28% to 31% of your gross monthly income.
But even if your new house payment will fall within this range, you need to be realistic about your financial situation and know what you can afford. Otherwise, you could experience cash flow problems after closing on the new mortgage.
You’re using the cash to improve your home
A cash-out refinance is useful when you’re using funds to improve your property’s value. This might include kitchen or bathroom renovations and other improvements like updating your flooring, installing new windows, or replacing your roof.