Cash-Out Refinance: Rates And Guide For Homeowners

Buying a home is probably one of the biggest investments you’ll ever make, and you likely want to do everything you can to make sure your home is as comfortable and as up to date as possible. But it can be tough to build up the necessary savings to complete home renovations and repairs.

A cash-out refinance may be your answer. It can help you accomplish your home improvement goals, so you don’t have to rely on credit cards, a personal loan or a second mortgage. A cash-out refinance can also help you use the money you’ve already paid into your mortgage to do things like cover repair bills, consolidate or pay off debt or even eliminate your outstanding student loans.

This article will walk you through the ins and outs of a cash-out refi so you can determine whether it’s right for you before you apply.

As your mortgage matures, you gain equity in your home. Equity refers to the amount of a home’s value that you’ve actually paid off or gained. You can gain equity in two ways:

1. Your home increases in value.
2. You pay down your mortgage principal through your monthly mortgage payments. Every time you make a monthly payment on your loan, you gain a bit more equity in your home.

A cash-out refinance is a type of mortgage refinance that takes advantage of the equity you’ve built over time and gives you cash in exchange for taking on a larger mortgage. In other words, with a cash-out refinance, you borrow more than you owe on your mortgage and pocket the difference.

Unlike when you take out a second mortgage, a cash-out refinance doesn’t add another monthly payment to your list of bills – you pay off your old mortgage and replace it with the new mortgage.

When you refinance, you can do anything you want with the money you take from your equity. You can make repairs on your property, catch up on your student loan payments or cover an unexpected medical or auto repair bill. Cash-out refinances give you access to lower interest rates than most other lending options, including credit cards. If you need extra cash to cover expenses, a cash-out refinance could be a great option.

Cash-Out Refinance Example

Let’s say that you’ve bought a home for $200,000 and you’ve paid off $60,000. This means you still owe $140,000 on your home. Let’s also say that you want to make $20,000 worth of renovations.

With a cash-out refinance, you take a portion of your equity and then add what you’ve taken out onto your new mortgage principal. This means your new mortgage would be worth $160,000 – the original $140,000 you owed on the home plus the $20,000 you need for renovations. Your mortgage lender will give you the $20,000 in cash a few days after closing.

The amount you’re able to borrow on your refinance typically depends on your home's value. Before finding out how much you qualify for, you'll need to have your home appraised. In general, lenders will let you draw out no more than 80% of your home's value, but this can vary from lender to lender and may depend on your specific circumstances.

One big exception to the 80% rule are VA cash-out refinances, which let you take out 100% of your existing equity.

Use A Refinance Calculator

If you’re looking to see how a cash-out refi will affect your mortgage rates, a refinance calculator is a quick and easy way to get an estimate. A calculator can also help you figure out how much money you could save each month with a rate and term refinance. Based on the goals you choose and the numbers you plug in, our calculator will tailor loan-type recommendations just for you.

The cash-out refinance process is similar to the process you undergo when you buy a home. After you know you meet the qualifying requirements, you choose a lender, submit an application and documentation to underwriting, get approved and wait for your check.

Let’s take a closer look at each of these steps.

1. Check The Requirements

Each lender sets its own requirements when it comes to deciding who qualifies for a refinance. Here are some of the most common cash-out refinancing requirements:

A Credit Score Of At Least 580

Depending on your mortgage loan type, you’ll usually need a credit score of at least 580 to refinance. Many lenders require higher credit scores for cash-out refinances. However, there are exceptions.

• Refinancing VA loans: If you’re eligible for a VA loan, you can take cash out with a median FICO^® Score of 580 or higher as long as there is at least 10% equity left in the home after you complete the refinance. You can take out up to the full amount of your equity with a 620 qualifying credit score using a VA loan.
• Refinancing FHA loans: An FHA cash-out refinance loan may be used to pay off debt if you’re an existing client of ours with a median 580 credit score. Otherwise, all other purposes for taking cash out require a 620 credit score.
• Refinancing conventional loans: Conventional loans always require a 620 qualifying credit score regardless of how much equity you’re borrowing.

A Debt-To-Income Ratio (DTI) Of Less Than 50%

Your DTI ratio is the amount of your monthly debts and payments divided by your total monthly income. For example, if you pay $1,500 in bills every month, including your mortgage, and you have a total monthly household income of $4,000, your DTI is $1,500 divided by $4,000, or about 37.5%. Most lenders prefer borrowers interested in refinancing their home loans to have a DTI of 50% or lower. However, it's possible to qualify with higher debt loads using FHA or VA loans.

Equity In Your Home

You’ll need to already have a sizable amount of equity built in your home if you want to secure a cash-out refinance. Remember that your lender won’t let you cash out 100% of the equity you have unless you qualify for a VA loan refinance. Take a careful look at your current equity before you commit. Make sure that you can convert enough equity to accomplish your goals.

2. Determine How Much Cash You Need

Once you know that you meet the requirements for a cash-out refinance, determine how much money you need. If you’re planning to use the funds for repairs or renovations, it’s a good idea to get a few estimates from contractors in your area so you know how much you’ll need.

If you want to refinance to consolidate debt, sit down with your credit card and bank statements and determine exactly how much cash you need to cover your debts.

3. Apply Through Your Lender

After you apply for a cash-out refinance, you receive a decision on whether your lender approves it  . Your lender might ask you for financial documents like bank statements, W-2s or pay stubs to prove your debt-to-income ratio. After you get approved, your lender will walk you through the next steps toward closing.

After closing, all that’s left to do is wait a few days for your check to arrive. The entire cash-out refinancing process can take 30 – 60 days from start to finish.

A cash-out refinance can provide several financial benefits and may present advantages over taking out a personal loan or second mortgage. Here are some reasons to consider getting a cash-out refinance.

Fund Home Improvements And Renovations

A cash-out refinance allows you to use the equity you’ve already earned to fund home improvements and renovations that can increase your home’s value. You’ll be able to get a lower interest rate on your refinanced mortgage than you would with a credit card, saving you a lot money on interest payments.

Use Debt Consolidation

A cash-out refinance can give you the money you need to pay down your debts and transfer what you owe to one convenient, lower-interest payment. You can use the funds to pay off as many high-interest debts as you have the money to cover. By doing this, you’ll reduce the amount you’ll pay in interest each month and may potentially free up money to help you pay down debts that aren’t part of your consolidation or to pay off your mortgage more quickly.

Get A Lower Interest Rate

Mortgage and refi rates are generally lower than credit card interest rates – often significantly lower. If you have enough equity in your home to cover your bill, you may save thousands in interest over time. Plus, if you got your original mortgage at a higher rate, you could secure a lower mortgage rate depending on market conditions.

Free Up Money To Invest

When you consider the power of compounding interest, it can be a smart move to free up money and save toward retirement early rather than keep your funds tied to your home. Cash-out refinances give you access to funds that you can use to boost your retirement savings or build up a college fund.

You might need to consider a few things before you commit to a cash-out refinance. Here are some important things all homeowners should keep in mind before applying for a refinance.

You’ll Probably Have To Leave Equity In Your Home

Let’s say you’ve paid a total of $20,000 on your mortgage principal. You might assume this means you can take up to $20,000 out with a cash-out refinance. However, depending on your loan and your lender, this isn’t always possible.

Conventional loans and FHA loans require you to leave 20% equity in your home after a refinance. If you’re refinancing a VA loan, your lender may allow you to borrow your full equity without penalty.

You’ll Pay Closing Costs

Just like when you buy a home or close on a home equity loan, you’ll pay closing costs when you refinance. Some common refinance closing costs include credit report fees, appraisal fees and attorney fees, depending on your state. If you only need to take out a very small loan, you should take a look at whether the closing costs would negate anything you save with a lower interest rate.

You Won’t Get Cash Immediately

Similar to when you buy a home, you must submit to underwriting and appraisal processes before your lender approves your refinance. The Truth in Lending Act requires your lender to offer you 3 days to cancel the loan if you have a change of heart after you close, and you won’t get your cash until a few days after closing. If you need money immediately, a cash-out refinance may not be the right solution.

Your Loan Terms May Change

When you get a cash-out refinance, you pay off your original mortgage and replace it with a new loan. This means your new loan may take longer to pay off, your monthly payments may be different, or your interest rate may change. Be sure to look at the Closing Disclosure from your lender and analyze your new loan terms before you close.

You’ll Need An Appraisal

Cash-out refinances are contingent upon an appraisal by an independent third party. Appraisals can take time, so factor this into your refinancing timeline. Keep in mind that the appraisal will determine how much your lender is willing to give you. Take the time to prepare your property by cleaning up the outside of your home, washing windows and fixing visible damage before the appraisal happens. This will make your home look nicer and increase the chances of the appraiser giving your property a fair assessment.

Cash-out refinancing, home equity loans and home equity lines of credit (HELOCs) are all methods of capitalizing on your home’s value, but there are important differences. A cash-out refinance replaces your existing mortgage with a higher loan amount, while home equity loans and lines of credit are additional mortgages.

When it comes to choosing a home equity loan versus a refinance, one way you can judge which is right for you is by looking at the interest rates. If you qualify for it, cash-out refinancing typically offers better interest rates, but may have higher closing costs. You’ll also want to factor in any potential refinance tax deductions that you may qualify for.

Consider these frequently asked questions before you opt for a cash-out refinance.

When is a cash-out refinance a good option?

A cash-out refinance is a great option for homeowners who need cash in hand, meet the requirements of the refinance loan and generally need no more than 80% of their home’s equity. Because of their lower interest rates, cash-out refinances can be a better option than financing with a credit card.

How much can I get with a cash-out refinance?

Generally, the amount you can borrow with a cash-out refinance is capped at 80% of your home value. However, this can vary depending on the lender and loan type you choose. For example, you can borrow 100% of your home’s equity through a VA cash-out refinance.

Do I have to pay taxes on a cash-out refinance?

Because the IRS considers a cash-out refinance an additional loan, you don’t need to list the cash you receive from your cash-out refinance as income on your taxes. However, the IRS does limit refinancing deductions you can take on your cash-out refinance with your taxes.

Cash-out refinance borrowers can deduct the interest on their original loan balance only if they use the equity to make improvements to the property’s value.

Will applying for a home equity line of credit let me borrow more than 80% of my home’s equity?

While it’s possible to find a lender willing to issue a home equity line of credit at more than 80% of your home’s loan-to-value ratio (LTV), most will expect you to leave at least 20% equity in your home. If you’re considering a HELOC over a cash-out refinance, discuss your options with your lender.

Does my credit score matter when applying for a refinance?

Yes. Most lenders require you to have a credit score of at least 580 to qualify for a refinance and 620 to take cash out. If your score is low, you may want to focus on improving it before you apply or explore ways to refinance with bad credit.

How will my monthly mortgage payment change after refinancing?

For most homeowners, your monthly mortgage payment will increase with a cash-out refinance because you’re borrowing more than you currently owe on your mortgage. However, if interest rates are lower than they were when you applied for your current mortgage, your payment may stay the same or go down.

Whether you want to pay down debt or renovate your kitchen, a cash-out refinance can be a powerful tool and can give you the money you need to move toward your goals. These loans typically offer lower interest rates than credit cards and home equity loans and have no restrictions on how you can use the money. Review your personal finances before applying, though, so you’re not taking on more than you can repay.

If you’re ready to get started, explore your refinance options with Rocket Mortgage today.