As your equity increases, you can refinance your mortgage and receive cash for that equity. With a cash-out refinance, you replace your old mortgage with a new one in a larger amount than your previous loan. Then you receive the difference, or an amount determined by lender. A cash-out refinance is a new mortgage and not a second mortgage.
Equity in your home can increase in a couple of ways:
- You’ve paid down the principle of the loan and owe less than 80% of the loan principle.
- Your home has increased in value which changes the loan-to-value rate. This can happen because you’ve done home improvements or because the market has changed.
How does a cash-out refinance work?
Let’s say Joe and Sue took out a mortgage for $300,000 ten years ago. They now want to do $40,000 worth of home improvements. They also notice that the interest rates have gone down since they first took out their loan. Instead of taking out a line of credit, they decide to do a cash-out refinance.
Since Joe and Sue purchased their home, they’ve paid $150,000 of their loan principle. They’ve built up 50% equity. The lender takes what they owe, $150,000, and adds the total cash they are taking out of their equity, $40,000. Their new refinanced mortgage principle will be $190,000. After they close, that cash is theirs to spend how they wish.
Important Questions about Cash-Out Refinance:
Do you meet the requirements?
- Credit score 620
- DTI (Debt-to-Income ratio) Limit: 50%
- Minimum 20% equity
- You can’t cash out 100% of your home’s value (VA loan is the exception)
Can you get what you need through the refinance?
Lenders won’t let you cash out more than 80% of your home’s value minus what you owe. They typically want you to leave 20% equity in your home. If you need more than that, then you may need other resources. In the example above, 80% of the value of Joe and Sue’s home is $240,000. Subtract the $150,000 they owed on the original loan and the total they could cash out is approximately $90,000. They have enough equity to do the improvements they planned.
How is a cash-out refinance different than a home equity loan or home equity line of credit (HELOC)?
With a cash-out refinance, you replace your existing mortgage with new mortgage at higher amount. You still only have one mortgage. A home equity loan or HELOC is an additional mortgage.
The best way to evaluate if a cash-out refinance is right for you is to look at your equity, the interest rates, closing costs, and any tax deductions that might come with the refinance.
