What Is A Cash-Out Refinance? What To Know

Thinking about tapping into your home’s equity and wondering, "What is a cash-out refinance?" Learn more about cash-out refinances and their benefits!

If you’re short on cash for a big project but have a substantial amount of equity in your home, a cash-out refinance might be the solution you’ve been seeking. This option can fund your financial goals while helping you avoid high-interest options, like personal loans or credit cards.

Learn more about how a cash-out refinance works, consider the pros and cons, and decide whether it’s worth exploring further.

What Is A Cash-Out Refinance?

Equity Explained

One of the many benefits of homeownership is the ability to build equity through paying down the principal balance on a mortgage or through appreciation, which is an increase in value.

For example, suppose you purchased your home for $275,000. The value of the home is now $325,000 and the principal balance on your mortgage is $200,000. This means you have $125,000 in equity due to appreciation and paying down the mortgage.

Accessing Equity

One way to access the equity in your home is through a cash-out refinance. This option allows you to receive a portion of your home’s equity in a lump sum and obtain a new loan with a larger principal balance than your current mortgage.

You’re free to use the funds as you see fit; homeowners often use the proceeds to make costly home repairs and improvements, pay off high-interest debt, contribute to a child’s college education, and fund investments. The possibilities are truly endless.

Things To Note

For most cash-out refinance mortgages, the maximum amount you can draw out is 80% of the home’s value. In the example above, that would be equivalent to $260,000; since you still owe $200,000 on the prior loan, however, that leaves $60,000 in equity available to borrow.

Perks

Cash-out refinances can be helpful for homeowners who have significant equity in their home. Here are some of the perks of this option.

Debt Consolidation

If you have other debts with a higher interest rate than your mortgage, using this to access cash to pay off debt can be helpful. Some people use this to pay off credit card debt, personal loans, or other high-interest debt.

It’s important to remember that you need to have sufficient equity in your home, and refinancing will involve receiving a new loan for a higher amount of your mortgage. This method can be a great way to address debt since mortgage rates are typically lower than other loans, saving you money.

Interest Rates

Interest rates can make a cash-out refinance especially attractive. They’re generally lower than similar loans like a home equity loan or home equity line of credit. Additionally, the current rate environment, an improvement in your credit score, and/or greater financial stability can contribute to qualifying for a rate that is lower than that of your existing mortgage.

Potential Tax Benefits

Another benefit is the ability to take advantage of the mortgage interest deduction on proceeds used to substantially improve your main home. Refer to the refinancing portion of this Home Mortgage Interest Deduction Publication from the IRS for more information.

On that note, it’s also important to understand that money drawn from a cash-out refinance isn’t considered income; therefore, you don’t need to pay taxes on it.

Flexible Use of Funds

One of the benefits of a cash-out refinance is that there are no rules as to what you use it for, whether that be for home improvements, paying off debt, education costs, medical bills, or creating an emergency fund.

Using a cash-out refinance can help your financial health by using it to take advantage of lower interest rates.

Build Or Rebuild Credit

Using the funds from a cash-out refinance to pay off high-interest debt, such as student loans and credit card balances, can help lower your credit utilization ratio and potentially boost your credit score. Additionally, paying off these debts simplifies your financial journey, as having fewer payments to manage makes it easier to stay on top of your finances.

Cons

Cash-out refinances can have downsides, such as reduced home equity, delays, and closing costs.

Closing Costs

Most mortgages have both fees and closing costs and this one is no different. Closing costs run about 2-5% of the new loan amount and can include lender origination, appraisal, and title fees. These costs and other details will be outlined in the Closing Disclosure you receive.

As noted, a cash-out refinance results in a completely different loan with a new set of characteristics, including interest rate, term, and payment amount. Make sure you fully understand the new mortgage’s ins and outs before finalizing anything.

Speed

Lastly, it can take a while to get from the application to close. Your loan can only move as fast as the different parties can go. One area that can cause delays, for instance, is the appraisal. In addition, it’ll take a few days after closing to receive funds due to your lender being required to provide three days to cancel the loan, known as the Right of Rescission.

Reduces Home Equity

You can tap into your home’s equity only so many times before it runs out. By choosing a cash-out refinance, you may leave yourself with less of a financial cushion for future emergencies. If property values drop, you could also owe more than your home is worth.

Other Options To Consider

If a cash-out refinance isn’t right for you, several alternatives can help you use your home’s equity to access funds.

Home Equity Loan

A home equity loan is basically a second mortgage loan that allows you to borrow money against your home’s equity. With a home equity loan, you open up an entirely separate loan from your mortgage, with its own repayment terms and interest rates. You can typically borrow up to 80 percent of a home’s equity, making it a popular choice for expenses like home improvements and debt consolidation.

However, home equity loans typically have higher interest rates than a cash-out refinance, and they can run the risk of foreclosure if you fail to make monthly payments.

Home Equity Line Of Credit

Known as a HELOC, a home equity line of credit uses your home as collateral and functions a lot like a credit card. A HELOC allows you to withdraw funds up to a pre-approved limit during a set period. HELOCs typically have lower upfront costs than a cash-out refinance, but often have variable interest rates that can lead to payment fluctuations.

Final Thoughts

First things first, determine how much you’ll need to fund your project to determine if you have enough equity and evaluate whether this option is a good fit for you.

A cash-out refinance only makes sense if the potential savings justify the cost of the new mortgage or is the best option for your situation. This can be the case with larger cash-out amounts, mortgages with an interest rate reduction, and mortgages with lower principal amounts (since closing costs are based on this).

A+ Can Help You Understand Cash-Out Refinancing

If you have significant equity in your home and are looking to access funds for a home improvement project, pay off high-interest-rate debt, or do any other project to fund your financial goals, a cash-out refinance may be the way to go.

At A+FCU, you can explore all of our options for refinancing, like our free Should I Refinance calculator and other expert guidance on your home’s equity. With a wide variety of resource tools, you can learn how to utilize your home’s equity to further your financial situation.

Membership required. LTV = Loan to Value. Programs, rates, terms, and conditions are subject to change without notice. Normal lending criteria apply. All loans subject to credit approval. Property must be located in Texas and primary owner-occupied single-family residence. $495 processing fee for loans less than $40,000. $795 processing fee for loans $40,000 and above. HELOC maximum loan amount of $250,000. NMLS #405608.