Cash-Out Refinance: Understanding When It’s Right for You

November 1, 2021


Purchasing a home is a big undertaking. For many, it’s one of the most significant purchases they’ll make in their lifetime. However, as great as homeownership is, it does come with its complexities, including the need for often expensive repairs and upgrades.

If you find yourself in need of funding for various home improvements, a cash-out refinance may be the right solution. It could help you achieve home renovation objectives without turning to high-interest credit cards, home equity lines of credit (HELOCs), or traditional bank loans. A cash-out mortgage could allow you to use your home equity to cover a variety of expenses such as a home renovation, debt consolidation, or even student loans.

Here, we’ll explain the advantages of cash-out loans and help you determine if it’s the right option for your situation. So, stop scouring the internet for cash-out mortgage articles! We have all the answers you need.

What is a Cash-Out Refinance?

A cash-out refinance replaces the current mortgage with a new home loan that’s larger than your existing one. Upon refinancing, you get the difference in cash, which can be used for home renovations, debt repayment, or other financial needs. Keep in mind that in order to qualify for a cash-out refinance, you need to hold equity in your home.

Compared to traditional refinancing, which replaces your current mortgage with a new one with the same balance, cash-out refinancing replaces your existing mortgage with a new one with a higher balance. A cash-out refinance functions as such:

  • Pays you a portion of the difference between the balance of your mortgage and the value of your house
  • Replaces your current mortgage with a new one (interest rate could be higher depending on your credit, income, and other factors)
  • Limited to a cash-out of 80% to 90% of the home’s equity (you need to leave some of your home’s equity untouched)

For example, if your house is worth $500,000 and you owe $200,000 on your mortgage, you have $300,000 in equity. With a cash-out refinance, you could secure a new loan for $250,000 and have $50,000 in cash at closing to use toward renovations.

How Much Cash Can You Get?

A cash-out refinance is a lending opportunity that helps borrowers swap their existing home mortgage with a mortgage loan that is a higher amount than the current one. The cash difference between the old and current mortgages is then made liquid, and the homeowner may use it on whatever other they like. Cash-out refinances are an excellent way to take advantage of the equity you’ve built up over the life of your original mortgage.

The amount of cash you will get with a cash-out refinance depends on the kind of mortgage you have and whether your credit score is high enough to secure one in the first place. Most lenders permit homeowners to borrow up to 80% of their home’s worth. For lenders who sell Federal Housing Administration (FHA)-insured mortgages, this figure could grow to 85%.

Reasons To Obtain a Cash-Out Refinance

What is a cash-out refinance used for and how can you leverage a cash-out refinance to achieve your goals? Here are a few examples of how the value of your home could help you.

Any type of mortgage refinancing has the chance of securing you a lower rate if the rates have decreased since you bought your house. Refinancing the debt at a lower interest rate could save you a lot of money throughout the loan’s term. However, it’s worthwhile to note that cash-out refinances could offer lower interest rates in comparison to other lending alternatives, such as home equity loans.

Projects for Home Improvement And Renovation

Home renovations are a common application of a cash-out refinance. They can be a fantastic choice if your home requires substantial upgrades. You may even apply your cash-out refinance funds into a new roof, green-energy alternatives, a home addition, or a significant kitchen remodel.

Debt Consolidation

A cash-out refinance may also be beneficial for debt restructuring. Interest rates on credit cards, car loans, and private student loans are typically higher than those on mortgages. Mortgage rates are synchronized with interest rates set by the federal government. The federal funds rate is at an all-time low and taking advantage of it by refinancing may be a wise financial decision.

Student Loan Payoff

Another factor homeowners consider when refinancing their mortgages is freeing up cash to spend on schooling. Using your home equity to pay for tuition could be a wise use of funds as it can help you or your loved ones achieve educational goals.

Reduced Interest Rate

You may be able to lower your current mortgage rate and receive cash back if rates are attractive. You could positively adjust the terms of your mortgage when refinancing, which can be more beneficial than drawing out a HELOC or a home equity loan. Note that HELOCs and home equity loans are two types of second mortgages, each with its own set of terms and interest rates. The terms on your new mortgage remain unchanged as you take out these kinds of loans.

Benefits of a Cash-Out Refinance

Interest rates on refinance mortgages are typically smaller than those on other loan types, making it a relatively cost-effective option to borrow capital. For example, if you use the money to pay down other loans such as credit cards or a home equity loan, the interest rate you pay on your mortgage could be smaller.

Longer-term loans provide flexibility and make payments more manageable. Mortgage loans can be paid off over a much longer time period than most forms of debt (up to 30 years).

If interest rates have fallen since you have taken out your original mortgage, a cash-out refinance could help you borrow more while still lowering your mortgage rate.

A significant benefit of a cash-out refinance is that mortgage interest is typically tax-deductible, meaning you could subtract interest accrued on the loan if you itemize deductions.

You can exclude mortgage interest charged on loan principal up to $750,000 for a couple ($375,000 for a single) if the funds are used to purchase, build, or upgrade a house. However, if you use the cash from your cash-out equity to pay for something else, like tuition or credit card debt, the IRS considers it as a home equity loan, and you can only subtract the interest up to a certain limit.

As previously stated, there are several advantages of refinancing. Bear in mind, though, that smaller sums would not qualify for refinancing due to final closing costs on the overall loan sum.

Important Things to Know About Refinance Cash Out

Now that you understand what a cash-out refinance can do for you, it’s time to determine if it’s the right choice for you. Here are some things to consider:

Current Amount of Equity in Your Home

One standard condition for a refinance cash out is that you leave 15-20% equity in your home after the refinance as a risk hedge. Before you take out the cash, it’s critical to decide if you have enough equity to achieve your target, whether it’s remodeling, debt repayment, or anything else.

Cash-Out Refinance Rules

To secure a cash-out refinance, there are certain requirements you’ll need to meet. These cash-out refinance prerequisites differ depending on the provider and debt class, however, you can anticipate the following to be considered a candidate:

  • More than 20% equity in your house
  • A new assessment to confirm the worth of your house
  • A credit score of at least 620
  • A DTI ratio of 43 percent or less (including the current loan)
  • An LTV ratio of 80 percent or less
  • Verification of your employment and income

While every lender will be different, these guidelines extend to the majority of traditional cash-out refinances.

Let Reali Help With Your Housing Needs

While a cash-out refinance is one avenue of leveraging your home’s equity, it’s best to explore all of your options. Our experts will be with you every step of the way, guiding and informing you on every decision.

At Reali Loans, we’re committed to providing the best financing solutions and removing the stress from real estate. Contact us today for more information on how your home can work for you!