The Definitive Guide to Cash-Out Refinancing

Everything you need to know about cash-out refinance loans and how the compare to other home equity sources of credit.

Are you considering a cash-out refinance? If so, now is a good time to get serious about it. National homeowner equity has been on the rise, increasing by $981 billion (12.3%) since last year.

But is a cash-out refinance the best way for you to access your equity? In this guide, you’ll learn everything you need to know, including:

  • What a cash-out refinance mortgage is and how it works.
  • What to know when shopping for a lender.
  • Answers to frequently asked questions.
  • The pros and cons of HELOCs, home equity loans, and cash out refinance mortgages.

What is a cash-out refinance mortgage?

In short, a cash-out refinance is a loan to refinance your mortgage and get a lump-sum of cash by using the equity in your home as security.

Home equity is the difference between the value of your property and the amount you owe on it. So if your property is worth $400,000 and you owe $250,000 on your mortgage, you would have $150,000 in equity.

When you have equity, you can refinance your mortgage and take out a loan that is greater than the amount you owe on your existing mortgage.

For instance, using the above example, let’s say you took out a loan for $300,000. You would pay off your old loan and have $50,000 left to cash out.

How does a cash-out refinance work?

You can break down a cash-out refinance into five basic steps.

  1. Get an appraisal to find out if you have equity in your home.
  2. Shop around for a lender that will offer you the best rates and terms on a new mortgage.
  3. Take out the loan and pay off your existing mortgage.
  4. Gain access to the excess cash.
  5. Make repayments to the new lender.

Next, let’s look at the factors to consider when shopping for a mortgage lender.

Shopping for a cash-out refinance mortgage

What should you be looking at when comparing mortgage lenders? Here are the basics.

Cash-out refinancing Fees

According to the Federal Reserve, the common fees include the following.

  • Application fee. A fee to cover the costs of loan processing and checking credit reports.
  • Appraisal fee. The cost to get the value of your house appraised.
  • Inspection fee. Lenders often require homes to be inspected for termites, sound structure, adequate water systems, and more. The requirements on what is inspected will vary by state and lender.
  • Closing/attorney fee. A fee paid to the company or lawyer that performs the closing for the lender.
  • Homeowners insurance. A homeowners insurance policy is required to protect your house against physical damage.
  • Survey fee. You need a survey to confirm the location of the building on a property. The survey may also look at improvements on the land. If one has recently been performed, this requirement may be waived.
  • Prepayment penalty. Some lenders charge a penalty if you pay off your existing mortgage early.
  • Title search and insurance fee. Lenders must conduct a title search to check for liens and confirm that you are the rightful owner of your property. If there is an oversight and a problem arises, title insurance protects the lender’s investment in your mortgage.
  • Loan origination fee. A fee which is paid to a lender or broker for preparing your loan.
  • Private Mortgage Insurance (PMI). PMI is usually a requirement on loans where more than 80% of the value’s property is being financed. This includes federal government housing programs such as the Federal Housing Administration (FHA) loans and conventional loans.
  • Points. One point is equal to 1% of your loan. You can buy points to lower your interest rate or may be charged points by your lender.

The average cost of each fee:

Be sure to figure out the total amount of fees that a lender will charge and compare them with at least two other lenders to find the best deal.

Cash-out refinancing Interest Rates

In addition to the above fees, you will pay interest on a cash-out refinance mortgage. The amount you pay will depend on the interest rate you receive from your lender.

Lenders use various approaches to analyze risk and assign interest rates, but often factor in your credit score, home, income, loan amount, and loan term.

Find out what rates you qualify for here.

LTV and cash-out refinancing

Loan-to-value is the amount of your available equity that you are able to borrow. For example, if a lender says it allows 85% LTV, you can borrow 85% of your total available equity.

Lenders will vary in the LTVs they offer. So make sure you check as this will impact the amount you can borrow.

Maximum loan amounts for cash-out refinances

Lenders also vary in the total amounts they will lend to you. For example, one lender may offer loans from $100,000 to $2.5M while another will offer them from $5,000 up to $50,000. Choosing the right lender will ensure you can borrow the amount you need.

Accessibility

The accessibility of a lender should also be considered. How easy is it to get the loan? Can you apply online? How long will the process take? Is the process streamlined?

Some lenders will be much easier (and quicker) to work with than others.

Customer satisfaction

Lastly, check how the lender ranks in customer satisfaction. You can find out by reading reviews from past customers. Are they generally happy with the service? Are there any recurring complaints?

Review and compare today’s leading lenders here.

By vetting lenders using these factors, you can find the one that offers the best overall value.

Frequently asked questions about cash-out refinance mortgages

Now, let’s cover some frequently asked questions about this loan product.

What does it mean to “cash out” when refinancing?

It means you liquidate a portion of the equity you have in your home through a loan.

How should I use the money I cash out?

It’s best if you use the money to invest in something that will earn you returns in the future or save you money. Otherwise, you may acquire a large debt and have nothing to show for it.

Recommended uses include paying for an education or professional training, making improvements to your home, buying an investment property, investing in a business venture, or consolidating debt.

How much can I cash out?

The amount you can cash out will depend on how much equity you have in your home. Your home will need to get appraised for you to find out its current value.

Once you have the value, multiply it by the LTV allowed by a lender. Subtract the amount you owe on your current mortgage and you will get the amount you can cash out.

For example, if your home is appraised at $325,000 and the lender allows you to borrow 90%, you could borrow $292,500. If you owe $192,500, you could cash out up to $100,000.

What is the minimum credit score for a cash-out refinance?

The minimum credit score requirements will vary from lender to lender. However, here are some general guidelines:

  • 620 or below. Difficult to get approved.
  • 621 to 699. May get approved but will have to pay higher rates.
  • 700 to 759. Should get approved but may not get the best rates.
  • 760 and higher. Will qualify and usually for the best rates.

Again, requirements and rates vary by lender so it’s a good idea to shop around.

When is a cash-out refinance a bad idea?

A cash-out refinance, or any type of refinance, may not be the best solution if your mortgage is more than 50% paid. Mortgages are amortized, meaning you pay the most interest in the beginning.

Slowly, over the duration of the loan, you pay more and more towards the principal. This enables you to gain equity faster. However, by refinancing, you will restart the amortization process so the majority of your payments will go to interest again.

A cash-out refinance also may not be beneficial if you have to pay a prepayment penalty on your current mortgage. Be sure to calculate the cost and weigh it against your savings and the benefits of pulling cash out.

What are the tax implications of a cash-out refinance mortgage?

According to recent federal tax changes, borrowers can deduct interest on up to $750,000 of qualified residence loans, which include primary mortgages. There is no tax on the cash taken out as it is not income.

Note: The interest on home equity loans and HELOCs is now only tax deductible if you use the moeny for home improvements.

Can I get a cash-out refinance on an investment property?

You can potentially get a cash-out refinance on an investment property, although you will need to meet the lender’s criteria.

Cash out refinance vs. home equity loan vs. HELOC

What is the difference between a cash-out refinance, a home equity loan, and a home equity line of credit (HELOC)?

Cash-out refinance

A cash-out refinance replaces your existing mortgage with a larger one. The difference between the new loan and the existing one is taken out as a lump sum.

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and the drawbacks of a cash-out refinance

Pros
  • Liquidate your equity in a lump sum.
  • Access equity without a second mortgage.
  • One loan, one payment.
  • Lower interest rate than you’d get on a second mortgage.
  • Interest is tax deductible up to $750,000.
  • Fixed interest rates.
Cons
  • Liquidate your equity in a lump sum.
  • Access equity without a second mortgage.
  • One loan, one payment.
  • Lower interest rate than you’d get on a second mortgage.
  • Interest is tax deductible up to $750,000.
  • Fixed interest rates.

Home equity loan

A home equity loan is a second mortgage. Your existing primary mortgage stays in place and you take out another loan to gain access to your equity.

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and the drawbacks to consider.

Pros
  • Liquidate your equity in a lump sum.
  • Keep the amortization benefits of your first mortgage.
  • Fixed interest rates and payments are available.
  • Typically lower fees than a cash-out refinance.
Cons
  • Second mortgage requires managing two loans.
  • Pay interest on the full loan amount whether you use it all or not.
  • Higher interest rates and fees than HELOCs.
  • Higher interest rates than cash out refinance mortgage.
  • Interest is not tax-deductible unless you use the loan to fund home improvements.

HELOC

home equity line of credit (HELOC) is also considered a second mortgage. It’s a line of credit, similar to a credit card that uses the equity in your home as collateral.

Once the draw period ends (typically 10 years), you can no longer withdraw from the credit line. You then have a set period to repay the amount (often 15 to 20 years).

WEIGH THE RISKS AND BENEFITS

Here is a list of the benefits and the drawbacks to consider.

Pros
  • No, or relatively low, closing costs.
  • Draw money as you need it (only pay interest on what you draw).
  • Second mortgage requires managing multiple payments.
  • Adjustable interest rates.
  • Easy and quick to secure.
  • Lower interest rate than home equity loan.
Cons
  • Second mortgage requires managing multiple payments.
  • Interest is not tax-deductible unless you use the loan to fund home improvements.
  • Adjustable interest rates can also cause your payments to rise.
  • No fixed interest rates.

Which is better?

It depends on your situation. You’ll have to weigh the pros and cons to determine which is the best fit for you. Cash-out refinance mortgages are often the most complicated to secure. However, it can save you the most in the long run, especially if your current mortgage costs are high.

Find the best cash-out refinance lender for you

Is a cash-out refinance mortgage the best route for you? It has become increasingly attractive as it is the only equity loan option offering tax-deductible interest no matter how you use the money.

But be sure you do your due diligence when picking a lender. Shop around to compare fees, interest rates, LTVs, loan amounts, accessibility, and customer service. After shortlisting at least three top lenders, choose the one that offers the best overall value.

Ready to start shopping? Review and compare today’s leading mortgage lenders here.

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