A cash-out mortgage lets you borrow more money than what you owe on the home and keep the excess.
Updated March 6, 2020|7 min read
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Cash-out refis are only available to borrowers who have enough equity in their homes
You can get a cash-out refinance loan for up to 80% of the home’s value
Cash-out refi rates are lower than credit cards, and even a home equity loan or line of credit
When you refinance a mortgage, you’re replacing your existing loan with a new loan. If you need cash, you can actually take out a mortgage larger than your current loan and receive the difference. This is called cash-out refinancing — you tap into your home’s equity and convert a portion of it to cash. You can use the money for everything from home repairs to educational expenses to consolidating your debt under a single payment.
But cash-out refinancing isn’t always a wise decision. When you refinance, you’re paying all of the same closing costs that you paid when you first took out a mortgage, and those fees could negate a good chunk of the cash you receive. Cash-out refinancing also means you have less equity in the home, which could make it harder to sell your home for a profit down the road.
Cash-out refinancing replaces your current mortgage with a new loan that’s more than the amount you owe on the house. The difference between your new mortgage balance and the total loan amount is given to you in cash and you can spend the money any way you like.
First, you need to have enough equity in your home to qualify for cash-out refinancing. If your home is appraised at $400,000 and your mortgage balance is $300,000, then you have $100,000 in equity or 25%. You get more equity the longer you own the home and make steady payments to reduce the mortgage loan balance.
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The amount of home equity corresponds with your loan-to-value ratio (LTV). If you have 25% equity in your home that means you have an LTV of 75%.
If you took out a mortgage recently, then you may owe too much on the loan (you have a high LTV), and the mortgage lender will not let you refinance yet.
Just as with a traditional mortgage refinance, you can also change the loan term or type (like going from a fixed-rate mortgage to an adjustable-rate mortgage, or ARM) with a cash-out refi.
Let’s say your house is valued at $400,000. After making steady payments for many years, your mortgage balance is now $200,000. You need money to pay for a semester of your child’s college tuition. If you get a cash-out refi for $260,000, you would pay off the remaining $200,000 of your old mortgage and keep $60,000 to pay tuition.
With conventional mortgages, lenders typically only allow you to get a cash-out refinance loan for up to 80% of the home’s value. Some mortgage lenders might allow as much as 90%. For a house valued at $400,000, the maximum cash-out refinance you can get is $320,000.
You can also get a cash-out refinance for government-backed loans, like FHA loans. In the past, you could refinance your mortgage into an FHA loan for up to 85% of the home’s value, but as of September 1, 2019, you now need to have an 80% LTV ratio or lower. You can also get a VA cash-out refinance if your LTV is 90% or lower. There may be other cash-out refinance requirements for federally insured mortgages, like a minimum credit score.
Cash-out refinancing, like traditional refinancing, means taking out a new loan and that includes paying all the associated costs again, too.
You’ll have to pay many of the same closing costs like you did when you initially took out the mortgage, like an appraisal fee and loan origination fee. Cash-out refis without closing costs do exist, but they’re misleading because the costs are typically just rolled into loan balance.
Closing costs for mortgage refinancing typically range from 2% to 6% of the mortgage loan. That means if you want to refinance for $200,000, you could be paying up to $12,000 in upfront fees.
Another hidden cost of cash-out refinancing is that you might have to pay private mortgage mortgage (PMI) again. Private mortgage insurance is required if you have less than 20% equity (or more than 80% LTV) in your home, so many homeowners pay it at the beginning of the loan term. As they continue making payments and gaining equity, PMI is eventually cancelled, but if you refinance for more money then you might be back where you started.
Using our example, if your lender lets you refinance for more than 80%, or a loan greater than $320,000, then you’ll have to pay mortgage insurance premiums. Learn more about private mortgage insurance here.
When you are looking into cash-out refinancing, consider what you need to use the money for and whether or not you’ll be able to pay it back. Cash-out refinancing may be worth looking into if you’re in a bind and need extra cash on hand for an important expense. Home improvement projects or repairs, which increase the home’s market value, are a common reason for cash-out refis. You may also be able to claim a mortgage interest tax deduction.
A cash-out mortgage can be a better option than using a credit card or even a personal loan, which may have higher interest rates. Cash-out refinance rates are also usually lower than the rates for a home equity loan or home equity line of credit (HELOC) as well. (We’ll go over those in the next section.)
Remember to compare the savings with the closing costs, which could negate the benefits of a low interest. If your credit score has increased and your debt-to-income ratio is more favorable than when you first bought the home, you may be able to land a low enough interest rate to make a cash-out refi worth it.
Or maybe today’s mortgage rates are simply trending much lower than they were when you first bought your home. In that case, you may only need a regular refinance so you’re not stuck paying off a larger loan.
Just be aware that the larger your loan is, the more you’ll have to pay back over time, so only take out what you absolutely need. It can be tempting to borrow the maximum amount that a lender allows, but you don’t have to. It’s never a good idea to borrow money you don’t need — or can’t pay back.
A cash-out refi isn’t a good idea if you’re planning to use the loan to pay for vacation or entertainment. A mortgage loan uses your house as collateral, which means if you don’t make payments you risk losing your home due to foreclosure.
Another popular use of the cash-out refis is to use the money to consolidate debt, like your student loans or credit card debt. If you’re considering using a cash-out refi for debt consolidation, crunch the numbers and make sure it’s actually saving you money in the long run. It might make more sense to simply pay off your short-term high-interest debt with your current cash flow. Read more about how to deal with your debt.
If you are satisfied with the current terms of your mortgage and don’t actually need to refinance, you should consider a second mortgage instead. Second mortgages like a HELOC and home equity loan both allow someone to borrow money against their equity.
Similar to a cash-out refinancing, a home equity loan or line of credit gives you access to up to 80% of your home equity, and that money can be put toward whatever you choose. Second mortgages also use your home as collateral, so you risk foreclosure if you fail to make payments. One key difference is that a home equity loan will be paid separately from your original mortgage.
If you’re not financially disciplined in the first place, a home equity loan or line of credit is no better than a refinance. If you struggle to make payments with either mortgage product, all you’re doing is just moving one debt from one source to another.
A home equity loan and line of credit differ in a few ways, including how money is disbursed to the borrower. One gives you a lump sum and the other lets you draw on the value like a line of credit. Learn more about HELOC vs home equity loans.
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