Since purchasing the first home I ever bought (way back in 2013, here's the story if you want to read!) I've written a lot about home buying. But as millennials age out of that “first time home buyer” phase, there are a lot of other financial terms they may not be familiar with. One of those is the cash out refinance.
A cash-out refinance is something I considered heavily when I was weighing my options back before my wedding in 2018. Did I want to sell the home? Or do a cash out refi and keep renting? I needed money to buy a home with my husband, but there's more than one way to use a financial asset. Feel me?
Below is a primer on the cash-out refinance: how they're different than a traditional refinance, why they're beneficial, and when it makes sense to use them.
How Does a Cash-Out Refinance Work?
A cash-out refinance works just like a regular mortgage refinance meaning your current mortgage gets replaced with a new one, except you take out a mortgage for the amount your home is worth, not what you owe on your current mortgage balance.
This means the difference between your mortgage and home value (your home's equity) becomes cash upon closing. Hence the name, cash-out refinance.
The new loan will be larger because you “cashed out” the equity (usually 80% of your home’s loan-to-value ratio). You can use the money for home improvements, debt repayment, or anything else you need the money for.
How Much Money Can You Get in a Cash-Out Refinance?
The amount of cash you get will depend on how much your home is worth based on an appraised value.
Just like with a normal refinance, or any time you go to take out any type of mortgage loan, there will be an appraisal, even if you bought your home fairly recently and mortgage values haven't changed.
Once the appraisal comes back, from there the lender will determine your loan-to-value (LTV) ratio. You won’t get 100% of your equity; typically it will be 80-90% of the LTV.
This happens because lenders like to make sure you keep at least 20% equity in the home after closing on the new loan.
Here’s an example of how much you may be able to get with a cash-out refinance:
Let’s say your house is worth $100,000, and you’ve paid down the current mortgage loan to $50,000. This would put you at around $50,000 in equity. You may be allowed to “cash out” up to $24,000. So your new loan would be for $74,000.
How Long Does a Cash-Out Refinance Take?
Similar to underwriting on a traditional mortgage or a refinance loan, a cash-out refinance normally takes between 30-45 days but can take as long as 90 days.
You can ensure the process goes faster by having all your documents in order before starting the process:
- Home documents – Insurance carrier information, property tax information, title documents, current mortgage statements, HOA documents, etc.
- Proof of income – Pay stubs, rental property income, alimony income, child support income, self-employment income, other income information, etc.
- Debt information – The lender may not ask for this information since they get it from your credit report but have it ready just in case. For example, alimony or child support payments.
- Tax returns – Something they may not need but have it ready just in case.
- Banking information – Just in case. Some lenders may require you to prove you have enough money in the bank to pay the first couple of months of loan payments.
What is the Minimum Credit Score for a Cash-Out Refinance?
As with any loan, you want to strive for your best credit score because this influences the interest rate you'll receive. (Click here to read our guide on how to build and improve credit.)
Exactly like when you go to take out a mortgage, a traditional refinance or cash out refinance is a BRAND NEW LOAN, so you'll have a new credit pull and get a new interest rate.
One of the biggest reasons many opt to refinance is because interest rates rise and fall with the economy and global markets. If you can get a lower interest rate, and refinance your mortgage to a lower one, you can save thousands in loan interest.
This is why refinancing can be a great financial tool and a savvy money move.
For example, when we bought our current home in November 2018, we received a 4.6% interest rate on our mortgage. Come June 2019, interest rates were much lower and I had a better credit score, so we were able to refinance to an 4.1% interest rate. Whether this is worth it depends on how large your mortgage loan is, or if you'd like to cash out and pay as little interest as possible on the new loan.
Also, be aware of closing costs and loan origination fees. Again, a cash out refi is still a new loan, so you'll want to review the numbers and make sure the loan fees and the increased monthly payment is worth it.
What about if I want to do an FHA cash out?
If you’re going for an FHA cash-out refinance loan, the requirements will be a 580 credit score, have at least 15% equity in the home at the time of refinancing.
Can I Sell My Home After a Cash Out Refinance?
The short answer is yes, but before you run out to sell, there are a few things you need to be aware of before you put your home on the market.
- Prepayment penalty – Make sure your new loan doesn’t penalize you for paying it off early.
- Owner occupancy requirement – Read your loan contract to see if it states you must occupy the residence for a certain amount of time after refinancing. If you sell your house too soon or rent it out, you could be sued for mortgage fraud.
- Evaluate, “Is it worth selling?” – Is the cost of selling your house after refinancing worth it? Tally up the fees and closing costs to see if you can recoup any profits by selling it so soon after a refinance.
Is a Cash Out Refinance Worth It?
It depends on what you're planning to do by cashing in on your equity.
You never want to use the cash to get into more debt! So using it for a vacation or a shopping spree is probably not worth it.
But it a cash-out refi is worth it when you can use the money to financial education fees, get out of high-interest credit card debt or to increase the equity in your home.
Here's when to consider a cash-out refinance:
- When refinancing can get you into a lower interest rate
- You have an LTV of at least 80% equity in your home
- There are home improvement projects you’re ready to work on
- You can easily afford the increase in monthly mortgage payments
What are the current rates for a cash out refinance?
Many factors go into the current refinance rates.
- Because the lending profile is different for a cash-out refinance, rates may be slightly higher.
- Rates may also change depending on the location, type of refinance, your credit score, home appraisal, and the percentage of cash-out you choose.
- You can also check Bankrate for daily rate updates.
Discover has a cool little cash-out refinance calculator you can use to see how much you might be able to get out of your house.
Lending Tree has a more in-depth calculator that you can use where you can input HOA fees, homeowner’s insurance, and property tax information so you can get a better picture of how much a cash-out refinance would cost you.