A cash-out refinance is one way to borrow cash at cheaper rates than you’ll find on credit cards or unsecured personal loans. It allows you to replace your current mortgage with a new one that covers both the cash you borrow against your home equity and the home itself. Our cash-out refinance calculator helps you estimate the monthly payments on your new mortgage.
Cash-out refinance costs include:
Closing costs can be paid out of pocket or subtracted from your cash-out funds. You may also be offered a no-closing-cost refinance option. However, this choice isn’t free — your lender will simply raise your interest rate or increase your loan amount and pay the costs on your behalf, which means a higher monthly payment and more interest charges over the loan’s lifetime.
A cash-out refinance can lower your monthly mortgage payment if current rates have dropped enough that your new, lower rate offsets borrowing more than you currently owe.
For example, let’s say you purchased a home with a $350,000 mortgage at a 7% fixed interest rate and monthly payment of $2,329. That was several years ago, and now your current loan balance is only $200,000.
If mortgage interest rates have dropped to 6% and you want to borrow an extra $25,000 ($225,000 total) to make some home improvements, your new monthly payment would only be $1,349. Despite tapping an extra $25,000 of equity, the lower rate and loan amount compared to your existing mortgage saves you $980 per month.
How much equity you’re required to have depends on what type of cash-out refinance you use. FHA loans, insured by the Federal Housing Administration (FHA), and conventional loans both allow you to borrow up to a maximum 80% loan-to-value (LTV) ratio. VA loans, backed by the U.S. Department of Veterans Affairs (VA), allow up to a 90% LTV for cash-out refinances. Your LTV ratio is the percentage of your home’s value that is financed by the loan.
For example, if your house is worth $450,000 and you owe $300,000 on your existing mortgage, you have $150,000 in available equity. Keeping the maximum 80% LTV ratio requirement in mind, you may borrow up to an additional $60,000 with a cash-out refinance. To calculate this, multiply your home’s value by 80% ($450,000 x 0.80 = $360,000) and subtract your outstanding loan balance from that amount ($360,000 – $100,000 = $60,000).
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A cash-out refinance involves refinancing your existing mortgage into a new loan that is larger than your current outstanding loan balance. This allows you to take the difference between your old loan and new loan in cash. You can use that cash for any purpose, such as debt consolidation, home renovations or an investment property purchase.
For an in-depth explanation of cash-out refinances, read our article about how a cash-out refinance works.
A cash-out refinance may a smart financial choice if:
You want to make home improvements. The lump-sum funds from your refinance could pay for kitchen upgrades or a new backyard deck.
You want to pay off high-interest-rate credit card debt. If you have maxed-out credit cards or high-interest-rate personal loans, you can consolidate them into one cash-out refinance loan. One drawback: The interest on the loan funds used to pay off your debt won’t be tax-deductible.
You need to cover college tuition expenses. Home equity cash may help pay for tuition, books or other higher education expenses.
You’re starting a small business or buying an investment property. Your home equity could provide seed money for a startup or help you start building a rental property portfolio.
A cash-out refinance may be a risky or unwise choice if:
The interest rate on your refinance loan is higher than your current mortgage rate. If your interest rate goes up, you’re volunteering to pay more than you have to in borrowing costs for every dollar of your original mortgage’s remaining balance.
You’re using the cash payout to consolidate debt. If you’re using the cash from a refinance to pay off short-term debts — like credit card debt — keep in mind that you’re going to pay interest on that money for a far longer time period. Don’t assume that a low interest rate is better than a higher one, because added time means added interest costs.
You want to use the money to buy luxuries or big-ticket items that depreciate quickly. It’s natural for cars, furniture or other fun potential purchases to catch your eye. But if you can’t afford to buy them with cash, you should consider whether you can afford them at all. It’s not wise to borrow money for items that will only detract from your financial health.
You don’t feel 100% confident that you can make the payments. If you have any doubt that you’ll be able to keep up with your payments, you shouldn’t take out any loan that uses your house or home equity as collateral. It’s not worth it to lose your home, damage your credit or go through the stresses of foreclosure. Instead, you could look into a personal loan — there are even fast loans that can get you cash as soon as today.
These four steps will give you a rough idea of how much home equity you can convert to cash.
Although the basic guidelines for a cash-out refinance are the same as a rate-and-term refinance, there are some important differences.
To qualify for a cash-out refinance, you must meet the following general requirements:
You’ll need to shop around to find the best refinance lender for you. Be sure to not only check with your existing lender, but gather refinance quotes from at least two other lenders. To get a feel for what’s out there, you can explore online lender reviews or ask for referrals from family and friends.
Pay attention to both the interest rates and annual percentage rates (APRs) of any loans you’re offered. Additionally, think about how long you plan to stay in your home. If you’re moving soon after your refinance, it might not make sense to go through the process of replacing your existing mortgage.
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