Cash-Out Refinance: A Homeowner’s Guide to How it WorksCASAPLORERTrusted & Transparent
What You Should Know
- A cash-out refinance lets you borrow money using your home equity
- The difference between the new mortgage and your old mortgage is the amount that you can withdraw as cash
- This cash can be used for any purpose, such as renovations and debt consolidation
- Most lenders allow a max LTV of 80% for a conventional cash-out refinance, or up to 90% with private mortgage insurance
- FHA cash-out refinances are also limited to an 80% LTV while VA cash-out refinances can have an LTV of up to 100%
What Is A Cash-Out Refinance?
A cash-out refinance is when you borrow a loan amount larger than your existing outstanding balance. The difference between what you are borrowing and the amount required to pay your existing mortgage loan is the cash that you are borrowing. A cash-out refinance allows you to use your home equity in order to borrow potentially large amounts of money at a low interest rate. These funds can be used for any purpose, such as debt consolidation, remodeling, and home renovations.
However, money from a cash-out refinance isn’t free money. You will eventually need to pay the borrowed money back, which is done with your regular mortgage payments. That’s why funds from a cash-out refinance are generally used for purposes that have a lasting benefit, such as saving you interest or increasing your home value.
Since you are replacing your existing mortgage with a new mortgage, you'll be able to change the terms of your mortgage when refinancing. In addition to receiving cash, a cash-out refinance allows you to change your monthly mortgage payments, to refinance to a shorter term to save interest, to refinance to a longer term to reduce your monthly payments, or to negotiate your mortgage interest rate.
Average Cash-Out Refinance Rates
According to Bankrate, the current average 30-year fixed refinance rate is 3.57% as of January 19, 2022. The current average 15-year fixed refinance rate is 2.90%. Cash-out refinance rates are slightly higher than refinance interest rates.
How a Cash-Out Refinance Works
How a cash-out refinance works can be broken down into three steps:
- Apply for a larger mortgage as a cash-out refinance
- Pay off your existing mortgage with your new mortgage loan
- Receive the leftover difference as cash to be used for any purpose
A cash-out refinance works by turning your home equity into cash. This is done by borrowing a larger mortgage loan than the amount that you currently owe. The amount that you can borrow with a cash-out refinance depends on how much equity you own. When you make mortgage payments, a portion of it goes towards your principal, while the other portion is the mortgage interest cost. Your principal payments turn into home equity that you own. Generally, you can borrow up to 80% of your home’s value. This means that cash-out refinancing won’t be an option until you own at least 20% equity of your home. It also means that a cash-out refinance will always increase the amount that you owe and decrease your home equity.
While you own your home equity, you won’t be able to access it directly. Selling your home is one way to turn your home equity into cash. A cash-out refinance allows you to turn your home equity into cash without selling your home.
Since you are fully paying off your existing mortgage with a new mortgage loan, you will end up with only one larger mortgage in the end. A cash-out refinance is not a second mortgage in addition to your existing mortgage. Since it is a new mortgage, you will have to pay closing costs for a cash-out refinance. Refinancing closing costs can add up from 3% to 5% of the new loan amount. This can include the cost of mortgage origination fees and home appraisal fees.
It can take a few days after closing for you to receive your cash-out, which is usually done in the form of a check. You can then deposit the check into your bank account and use the money without limitations.
How Much Can I Borrow in a Cash-Out Refinance?
The amount of money that you can get from a cash-out refinance depends on your home value, existing mortgage debt, and the maximum loan-to-value (LTV) ratio allowed by your cash-out refinance lender. The larger your existing mortgage debt, the less home equity that you own, and so the less you will be able to borrow. Since you’re cashing out on your home equity, a good deal of your lender’s attention will be on your LTV ratio. Most cash-out refinance lenders allow for a maximum LTV ratio of 80%. This means that you won’t be able to cash-out at least 20% of your home’s value. To easily find out how much cash you can borrow, you can use a cash-out refinance calculator.
The maximum amount that you can borrow can also be limited based on your loan type. For example, FHA cash-out refinancing has a maximum loan limit based on your county’s FHA loan limit. In most counties, the FHA loan limit is $420,680 for 2022, but it can go up to $970,800 in some high-cost counties. You won’t be able to get an FHA cash-out refinance for more than this amount. Some jumbo loan lenders might also have restrictions on jumbo loan cash-out refinances. For instance, they might require a piggy-back loan of 75/10/15.
To see an example of how a cash-out refinance works, let's say that your home value is $350,000, your current mortgage balance is $250,000, and your lender is letting you borrow up to an LTV ratio of 80%. How much cash can you get from a cash-out refinance?
First, you will need to calculate your maximum borrowing amount. Your lender has a max LTV ratio of 80%. The LTV ratio is based on the loan amount compared to the value of your home. 80% of your home’s value is $280,000. You will be able to get a mortgage for up to $280,000 based on your home value of $350,000. Second, you will decide how much more you want to borrow over your current mortgage amount of $250,000. If you borrow the maximum amount of $280,000 and use it to pay off your current mortgage, you are left over with $30,000. This $30,000 is the amount in cash that you can withdraw.
Can a Cash-Out Refinance Exceed an 80% LTV?
Yes, you can borrow more money from a cash-out refinance above an 80% LTV with a VA loan. In fact, VA loans allow you to cash-out refinance up to 100% of your home’s value. FHA loans no longer allow you to exceed an 80% LTV for cash-out refinances. Some lenders may offer conventional cash-out refinances for up to 90% LTV. However, you will need to pay for private mortgage insurance (PMI) if your cash-out refinance causes your mortgage to end up with an LTV of 80% or more.
How to Cash-Out Refinance Up to 100 Percent of Home Value
In order to cash-out refinance for up to 100% of your home value, you will need to cash-out refinance with a VA loan. A VA cash-out refinance has a max LTV ratio of 100% depending on your lender. However, you will need to meet the requirements of a VA loan. This includes being a qualified veteran or service member.
Cash-Out Refinance Requirements
Having enough home equity doesn't mean that you are automatically approved for a cash-out refinance. You will still need to meet your cash-out refinance lender's requirements, which are typically the same as a regular refinance. Typical minimum requirements to qualify for a cash-out refinance include:
- Credit Score: The minimum credit score for a conventional cash-out refinance is 620. For FHA cash-out refinance and VA cash-out refinance, some lenders may allow a minimum credit score of as low as 580.
- Debt-to-Income (DTI) Ratio: A maximum DTI ratio of 43% is allowed by lenders, however, there are lenders who can go up to 50%. The DTI calculation will include your new mortgage loan amount.
- Home Appraisal: An appraisal is required to determine the value of your property.
- Financials: Employment, credit records, assets, bank statements, and income tax returns will be required for the refinance process.
- LTV Ratio: The maximum loan-to-value (LTV) ratio for a conventional cash-out refinance is 80%. In other words, you will need to have at least 20% equity in order to qualify for a cash-out refinance. VA cash-out refinancing may allow for a higher LTV ratio.
Cash-Out Refinance Closing Process
A regular "rate and term" refinance will generally take around 30 to 45 days, while a cash-out refinance can take between 45 to 60 days. The cash-out refinance process is longer and may involve more paperwork than a regular home refinance. Your income and employment will need to be verified. You might be required to provide pay stubs and W-2 forms. It’s a good idea to compare mortgage lenders for the best rates, as you aren’t required to get a cash-out refinance with your current lender. Even so, refinancing with the same lender can simplify and shorten the closing process.
For closing, you will need to bring your ID, proof of homeowners insurance coverage, such as a homeowners insurance binder, as well as payment for the closing costs. You can choose to pay the cash-out refinance closing costs at closing or you can have it included into your mortgage loan balance. Rolling the closing costs into your loan balance is similar to a no-closing-cost mortgage as it allows you to avoid paying them upfront.
When Do I Get the Cash From a Cash-Out Refinance?
You will receive a check from your lender three business days after closing. Cash-out refinances have a three-day right of rescission period. During this time, borrowers can choose to cancel the cash-out refinance within three days of closing. Once that period has passed, you will receive the cash from the cash-out refinance.
You can choose to waive your right of rescission in order to receive your cash-out refinance money faster under certain circumstances. In order to waive your right of rescission, you will need to provide a written statement detailing your personal financial emergency and how it requires you to receive the money before the end of the required waiting period.
Advantages and Disadvantages of a Cash-Out RefinanceAdvantages
- Lower Mortgage Rate: In most cases, a mortgage is refinanced when the current mortgage rate is lower than the mortgage rate you were locked into when you first started the mortgage. Lower mortgage rates can save you money not only in terms of total interest paid but also with lower monthly mortgage payments. If you bought a $400,000 home in 2015 with a 30-year fixed at 4%, your mortgage payment would be $3,000. Whereas if you bought a similarly valued home in 2021 at the current rate of 2.25%, your mortgage payment would be $2,625, or 12.5% lower. Use our refinance calculator to determine your total savings from refinancing.
- Consolidating Debt: If you have other forms of debt such as credit cards or student loans that have very high levels of interest, then a cash-out refinance at a lower rate can help you save on interest payments in the long run.
- Credit Score: You can improve your credit score if you pay off your credit cards and other debt with the funds you get from the cash-out refinance.
- Tax Deductions: If the funds from the refinance are used to increase the value of the home in the form of renovations and safety standards, the interest paid on the cash-out refinance can be claimed as interest deductions. This can include adding a swimming pool, adding a fence to the boundary, roof repair, temperature control systems, and security systems.
- Collateral: In the event that you do not make your refinanced monthly mortgage payment, the lender can claim the collateral which is your home. Therefore, it is important to know the risks of using a cash-out refinance.
- Refinance Fees: In order to obtain a cash-out refinance, you need to be able to refinance your mortgage. Refinancing has closing cost fees which can range from 3% - 5% of the new loan amount.
- Mortgage Insurance: If you borrow more than 80% loan-to-value (LTV) ratio then you will be required to get private mortgage insurance (PMI). PMI protects the lender in the event that you default on your repayments. PMI fees can range from 0.4% - 2.25% of the loan amount.
- New Loan Terms: Replacing your existing mortgage means that you may get a new interest rate. If rates have risen since you got your original mortgage, it might mean that your new interest rate will be higher. Your loan term length might also be reset to 30 years. This could mean that you will be starting over and need to make mortgage payments for the next 30 years.
Types of Cash-Out RefinanceFHA Cash-Out Refinance
An FHA cash-out refinance is when you replace your current mortgage with a new FHA loan. You don't need to have a current FHA loan in order to get an FHA cash-out refinance. The benefit of getting a cash-out refinance to an FHA loan is that they have lower minimum credit score requirements and that they may have lower interest rates.
You will only be able to borrow up to an 80% LTV with an FHA cash-out refinance. The maximum FHA cash-out refinance limit was last changed in 2019, when HUD reduced it from 85% to 80%. This LTV change was announced in the Department of Housing and Urban Development’s Mortgagee Letter 2019-11. Before 2009, the maximum LTV limit was 95% for amounts up to $417,000, with a limit of 85% if exceeding $417,000.
An FHA cash-out refinance has additional requirements compared to a conventional refinance. This includes:
- You need to have lived in the home being refinanced for at least 12 months as your primary residence.
- Your mortgage payments for the past 12 months must have been paid on time.
For example, you cannot get an FHA cash-out refinance for a vacation home, second home or rental property, while a conventional cash-out refi allows you to do so. Since you are getting an FHA loan, you will also need to pay FHA mortgage insurance premiums (MIP) regardless of your LTV ratio. This includes both an upfront fee and an annual fee. With a conventional cash-out, you can avoid paying for mortgage insurance by keeping your LTV under 80%.
If you already have an FHA loan, you won’t be able to use an FHA streamline refinance in order to cash-out. Instead, you will need to cash-out refinance without the streamline option.VA Cash-Out Refinance
A VA cash-out refinance loan, also called a Type 2 cash-out refinance, allows eligible borrowers to refinance to a max LTV of 100%. This means that you can cash-out up to 100% of your home equity. You don't need to have an existing VA loan in order to get a VA cash-out refinance either. However, since you are getting a new VA loan, you will need to be eligible by being a veteran or service member. The max LTV limit for a VA cash-out refinance in Texas is also limited to 80%.
Similar to an FHA cash-out refinance, you cannot cash-out refinance a vacation home or second home with a VA loan. Instead, VA cash-out refinancing can only be done for owner-occupied homes. There is no maximum loan amount for a VA cash-out, besides the maximum LTV limit of 100%. For example, if your home value is $800,000, then you may qualify for a VA cash-out refinance of up to $800,000 before closing costs.
You will still need to pay the VA funding fee for a VA cash-out refinance. The VA funding fee for a first-time VA cash-out refinance is 2.3% of the loan amount, and subsequent cash-outs have a VA funding fee of 3.6%. This makes it equivalent to a VA funding fee for a VA loan with a down payment of less than 5%.USDA Cash-Out Refinance
You cannot cash-out refinance a USDA loan. However, you can get a USDA construction loan in order to build or repair a home. If you are looking to finance your home repairs, you may borrow up to 100% of your home's appraised value. This construction loan can finance the whole construction project or partially contribute to the project. For example, a USDA construction loan can be used to buy concrete for the foundation. A borrower could estimate the amount of concrete needed for their project and request a loan for that amount. The use of the funds is limited to construction and repairs only. This makes it a much more limited option compared to a cash-out refinance.
Cash-Out Refinancing and Taxes
The cash that you receive from a cash-out refinance is not considered to be income. Instead, the cash amount is viewed as a loan. This means that you do not pay taxes on cash from a cash-out refinance.
You can use the cash received from a cash-out refinance for anything, such as paying off debt or for a vacation. In some cases, you may even deduct interest when filing your taxes if you use the cash-out refinance for home improvements, such as fixing your roof or adding an addition to your home.
In order to qualify for the mortgage interest deduction, the cash from a cash-out refinance would need to be used for improvements that increase your home’s value. If you use your cash-out refinance money for other purposes, such as debt consolidation or a vacation, then you won't be able to deduct the full amount of your new mortgage interest. Instead, you will only be able to deduct interest from your original mortgage balance.
For example, let’s say that your original mortgage is $200,000. You want to borrow an extra $100,000 to replace your roofing, build a new bedroom, and remodel your kitchen. With a cash-out refinance of $300,000, the entire interest cost is eligible for the mortgage interest deduction. If you borrow $100,000 to consolidate debt and for other spending, then only the interest on the original mortgage balance of $200,000 is eligible for the interest deduction.
Cash-Out Refinancing Alternatives
- Home Equity Line of Credit (HELOC): If you have had a mortgage for a couple of years, you have probably increased your equity or ownership stake in the home. A home equity line of credit (HELOC) lets you borrow funds against the equity that you own in the home, using the home as collateral. It works like a credit card where funds can be borrowed and repaid providing flexibility to the borrower. In order to calculate your monthly expenditure with a HELOC, use our HELOC payments calculator.
- Home Equity Loan: In this type of loan, you can borrow a lump-sum amount depending on how much equity you own in the home. It is similar to a HELOC as home equity determines how much you can borrow, and the home is the collateral. However, in a home equity loan, you receive a lump-sum amount rather than a revolving credit.
- Personal Loan: You can borrow funds without putting up your home as collateral by taking a personal loan. The interest rate charged for a personal loan is higher than a HELOC or home equity loan as the lender has a higher risk due to the lack of collateral.
- Reverse Mortgage: A reverse mortgage allows senior homeowners to borrow money using their home equity without needing to make any further mortgage payments. The lender can pay you through installments to set up a steady stream of cash, or you can receive a lump-sum amount. Instead of making mortgage payments, the interest accumulates and is taken out of your home equity. This type of loan is used by senior citizens who use their equity in the home to receive monthly payments by lenders, creating another source of income during retirement.