A Cash-Out Refinance Is A Way To Access Cash By Borrowing Against The Equity In Your Home
With a cash-out refinance, you get a new home loan for more than you currently owe on your house. The difference between that new mortgage amount and what you owe on the previous mortgage goes to you at closing. You can spend the money on home improvements, debt consolidation or other financial needs.
However, you’ll now be repaying a larger loan with different terms. Therefore, it’s important to weigh the pros and cons before committing to a cash-out refi.
What is a Cash-Out Refinance?
With a standard rate-and-term refinance, you get a new interest rate or mortgage term without changing the balance of the loan.
You might do this because rates have gone down or because you need to add or remove a borrower.
A cash-out refinance gives you a new loan that’s larger than your current mortgage balance and you pocket the difference.
How much cash you’re eligible to access depends upon your home’s equity. This is how much your home is worth compared to how much you owe.
Steps to getting a Cash-Out Refinance
- Determine your home equity. Home equity is the market value of your home minus what you still owe. For example, if your home is worth $300,000 and you have $100,000 remaining on your loan, you have $200,000 in home equity.
- Calculate the maximum loan you can take out. In general, that’s 80% of your home’s value. Using the previous example, you would multiply $300,000 times 0.80 for a maximum of $240,000. Remember that this isn’t the same as 80% of the purchase price; your home’s value may be different now than it was when you bought it.
- Subtract your current mortgage balance. From that new $240,000 loan, you’ll have to pay off what you still owe on your home: $240,000 – $100,000 = $140,000.
- Estimate your total. In a cash-out refinance, you receive the difference between the balance on your previous mortgage and your new, larger mortgage. In this example, it’s as much as $140,000.
- Shop rates from multiple lenders. This will help you to get the best deal.
- Weigh alternatives. Once you’ve researched available rates, calculate your new monthly mortgage payment and determine if it makes sense and is affordable for you. If not, you may be better off pursuing another type of loan.
Submit an application. As with your original mortgage, you’ll have to go through the appraisal and underwriting process before closing on the loan and accessing your cash.
Cash-Out Refinance Requirements
In order to get a cash-out refi, you’ll have to meet lender requirements. These can vary across lenders, so it’s smart to shop around for the best interest rate.
But you’ll likely need to meet these qualifications:
Debt-To-Income Ratio
Your DTI is your monthly debt payments, including your current mortgage, divided by your gross monthly income. For a cash-out refi, you’ll usually need a DTI of 45% or less. If your DTI is over 45%, you may be required to have six months of reserves in the bank.
Credit Score
You may qualify for a cash-out refinance with a score of 620. However, a higher credit score will help you get a better interest rate.
Home Equity
You’ll usually need at least 20% equity in your home to qualify for a cash-out refinance. In other words, you’ll need to have paid off at least 20% of the current appraised value of the house.
Seasoning Requirement
With a conventional loan, you’ll need to have owned the house for at least six months to qualify for a cash-out refinance, regardless of how much equity you have. Lenders might make an exception if you inherited the property or it was otherwise legally awarded to you.
VA loan borrowers must wait at least 210 days, while borrowers who have a loan backed by the Federal Housing Administration need to have lived in the home for at least 12 months before doing an FHA cash-out refinance.
Alternatives Co Cash-Out Refinance
There are ways to tap into your home equity without doing a cash-out refinance. Home equity loans and home equity lines of credit (HELOCs) also allow you to borrow against your home equity. They’re both types of second mortgages, which means you take them out in addition to your current mortgage.
Home Equity Loan
A home equity loan allows you to borrow a lump sum. This is not too different from what you’d get with a cash-out refinance. However, since you aren’t touching your primary mortgage, its interest rate won’t change. With a home equity loan, you can typically borrow around 80% or more of your home’s value.
Home Equity Line of Credit
A HELOC is more flexible, giving you a line of credit that you draw from as needed. Most HELOC lenders let you borrow up to 80% of your home’s value, minus what you still owe.
Both home equity loans and HELOCs have minimal closing costs. However, the rates are generally higher than you’d get with a cash-out refinance because they are second mortgages.
