Are you looking for a way to tap into your home equity and get some extra cash? A cash-out refinance might be the solution you need. But what exactly is a cash-out refinance and how does it work?
For homeowners who have built up a home equity line, a cash-out refinance can provide a way to access that equity and use it for various purposes such as home improvements, debt consolidation, or funding major expenses. It can be an attractive option for those in need of a large sum of money, but it's important to understand the process and potential risks involved.
In this article, Benzinga will delve into the details of what a cash-out refinance is, how it differs from a traditional refinance loan and the factors you should consider before deciding if it's the right financial move for you. By understanding the ins and outs of a cash-out refinance, you can make an informed decision about whether it's a viable option for your financial and mortgage refinance needs.
How Does a Cash-Out Refinance Work?
A cash-out refinance replaces your current mortgage with a new loan. The new mortgage is for more than you owe on your home, which allows you to take out cash at closing. The amount you can take out is based on the amount of equity you have in your home.
So, what’s equity? Your equity is the value of your home less the amount you owe on it. Let’s say you have a home that’s valued at $250,000. You have a mortgage balance of $150,000. That means you have $100,000 in equity ($250,000 - $150,000 = $100,000).
If you decide you want to remodel your home at $25,000, then you could finance it with a cash-out refinance. You would work with a lender and take out a new mortgage for $180,000. That would allow you to pay off your mortgage ($150,000), pay closing costs ($5,000) and take $25,000 in cash shortly after closing.
Best Cash-Out Refinance Lenders
Which lenders are best when it comes to refinancing? Here are Benzinga’s picks.
Current Refinance Rates
There’s a lot to consider when it comes to refinancing, but 1 of the most important factors is the rate. How does the cash-out refi rate compare to your current mortgage? Here are current refinance rates.
Cash-Out Refinance Process
The cash-out refinance process is similar to the process of buying a house. In other words, it’s not an overnight process. If you need cash tomorrow, this probably isn’t the way to go. Here are the steps:
- Find a lender: It’s best to contact at least 2 or 3 lenders before you commit. Why? Every lender is different. They might have different interest rates. Some lenders might charge more fees than others. Or 1 might really impress you with its service.
- Complete the application: Once you know which lender you want to work with, you’ll need to complete an application and submit documentation. Your lender will let you know exactly what you need, but you’ll typically be asked for:
- Your tax returns from the past 2 years
- W-2s from the past 2 years
- Paystubs from the past month
- Bank statements from the past 2 months
- Go through underwriting: Just like when you bought your home, your lender will need to review your information and decide whether to approve you for the new loan. Your lender will consider:
- Your credit score. The minimum credit score varies by lender, but you’ll typically need at least a 620 to qualify for a cash-out refinance.
- Your debt-to-income (DTI) ratio: This number compares your monthly debt payments to your pre-tax income. Lenders usually require your total debt payments (including your new mortgage) to be 50% or less than your monthly income.
- The amount of equity in your home: Most refinances require you to leave at least 15% equity in your home. A $250,000 refinance means you would need to leave $37,500 in equity.
- Appraisal: Your lender may also request an appraisal to confirm the value of your home.
- Closing: Once your lender has all your information in hand, it will let you know if you’ve been approved. If you are, you’ll work with your lender to set up a time to complete your closing documents. You’ll also need to pay any closing costs that aren’t being rolled into your loan.
- Get your cash: You typically won’t receive your cash-out funds until at least 3-5 days after closing. This is because you’re able to cancel the transaction for 3 days, per federal law.
When Should You Take a Cash-Out Refinance?
Here are a few situations where it makes sense to take out a cash-out refinance:
You’re Making Home Improvements
Home improvements can increase the value of your home, which increases your equity. If you feel confident about the costs of your home improvements, a cash-out refinance allows you to borrow funds without adding another payment to your life.
You’re Paying for Educational Expenses
Student loans may have a higher interest rate than a cash-out refinance. If that’s the case, it might make more sense to fund educational expenses with a cash-out refinance.
You Have High-Interest Debt
If you have high-interest credit card or other debt, a cash-out refinance is one way to consolidate it. Make sure you’re committed to not incurring more credit card debt, though. Otherwise, you could end up with a higher mortgage balance and more credit card debt.
The Terms Make Sense
If you can get a cash-out refinance for a lower interest rate than your current mortgage, you’ll be in great shape. If the interest rate is close, make sure the monthly payment is affordable and that the move makes sense.
When Should You Not Take a Cash-Out Refinance?
Here are a few situations where it might not make sense to do a cash-out refinance.
You’re Not Sure How Much Money You Need
A cash-out refinance works best if you know exactly how much money you need. If you’re not sure, you may want to consider a home equity line of credit (HELOC), which has more flexibility.
The Interest Rate is Too High
If the interest rate on a cash-out refinance is significantly higher than your current mortgage, it may not be the best move. You don’t want to end up in a worse position, and you may not be able to refinance again for a lower rate.
You’ll End Up With Private Mortgage Insurance (PMI)
If you have less than 20% equity in your home, lenders often require PMI. This insurance protects the lender if a borrower stops making payments on a home. That means you’ll have a larger monthly payment for your home, which eats into your budget.
You’re Not Sure How You’ll Use It
It’s best to take out a cash-out refinance for an immediate need (medical bills, home improvements, educational expenses). If you’re not sure how you’re going to use the money, it could be tempting to spend it on other things rather than saving it for a rainy day. It’s best to have a plan in mind for the funds.
Is a Cash-Out Mortgage Refinance Right for Me?
Whether a cash-out refinance is right for you depends on your situation. Here are a few things to keep in mind.
- It’s secured by your home. Just like your current mortgage, a cash-out refinance is secured by your home. That means that if you can’t keep up with the payments, the lender can foreclose on the home. Make sure the cash-out refinance is affordable.
- You’re starting fresh. If you’ve been paying on a 30-year mortgage for 15 years and you take out a 30-year cash-out refinance mortgage, you’ll be paying for another 30 years. You can make extra payments, and that may be the right move for you. It all depends on your situation.
- You may be able to deduct the interest on the new debt. You may be able to deduct the interest on the cash you take out if you use it to substantially improve your home. That typically means your improvements add value to the home or adapt it, so it’s more accessible. Consult a tax professional to find out for sure, though.
- You pay closing costs. Closing costs can add up to thousands of dollars, so you typically only want to do a cash-out refinance if you’re taking out enough to make the closing costs worthwhile.
Refinancing your home is a process, and it’s not 1 you want to rush. Explore options using refinance calculators. Contact multiple lenders and review each quote carefully. Compare the interest rates and closing costs. If you’re planning to use the proceeds to pay off debt, have a plan for how you’re going to stay on budget.
A cash-out refinance can be a powerful tool for improving your financial position. Look at the big picture, have a plan and do what’s right for you.
Frequently Asked Questions
Does a cash out refinance work?
A cash out refinance works by taking out a mortgage larger than your current loan and receiving the difference.
How long do you have to wait to get a cash out refinance?
For a VA loan, you have to wait six months to get a cash out refinance. For an FHA loan, you have to wait 12 months.
What are the fees for a cash out refinance?
You will pay three to five percent when you take out a cash our refinance for origination and appraisal fees.
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