Cash-Out Refinance
Depending on how long ago you bought your home, its value has very likely increased. It may have increased a lot. Hold that thought, and consider this: If you need money for something important, like educational expenses, paying down higher interest rate debt, or making home improvements, where will you get it?
Credit cards and personal loans are two options, but the interest rates are high. Could your home be the solution? Yes. You may be living in the answer to your financial needs.
What is a cash-out refinance?
When you refinance, you replace your current mortgage with a new one. People often refinance for a lower mortgage interest rate or a shorter loan term. These mortgages are referred to as rate and term refinances, and are for the same amount as your current home loan.
A cash-out refinance, on the other hand, is exactly what it sounds like. You refinance for a larger amount and take out the difference in cash. The key is you must have enough home equity to access as the source of that money. What’s equity? It’s the difference between what you owe on your current mortgage and your home’s appraised value. You gain equity every time you make a mortgage payment (assuming you don’t have an interest-only loan), and when home values rise in your area.
How does a cash-out refinance work?
The goal of a cash-out refinance is for the borrower to unlock the equity in their home by taking out a new, larger mortgage and receiving the additional funds in cash. Here’s a very simplified example.
You bought your home 5 years ago for $300,000, put 20% down ($60,000), and took out a mortgage for $240,000. Home values have increased since then, and your home is now worth $400,000. You leave 20% equity in your home (that’s now $80,000), refinance for $320,000, and get the difference between what you owed on your old mortgage and your new loan amount as cash.
This example is for illustration purposes only and does not represent an actual loan.
Cash-out refinance requirements
To get a cash-out refinance, you’ll need to meet lender requirements, including for debt-to-income ratio<6.1.6 debt-to-income ratio calculator> and credit score. Generally you have to have owned your home for at least six months or more, depending on the loan type. Most importantly, you’ll need to have enough equity in your home to make it possible to take funds out, because with the exception of a VA cash-out refinance, you won’t be able to borrow 100% of your home’s value.
Types of cash-out refinance
Just as there are many kinds of purchase and refinance home loans, so are there different kinds of cash-out refinance loans.
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Conventional cash-out refinance
You’ll need to meet the same credit, income, and asset requirements as any other conventional loan. You’ll be able to borrow up to 80% of your home’s appraised value, and you won’t have to pay mortgage insurance.
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Conventional student loan cash-out refinance
While paying student loan debt is one use for the funds from any cash-out refinance, there’s a loan designed specifically for this purpose that may be a better choice. The cash goes directly to paying off student loan debt, and you must have enough equity to pay off at least one student loan. You still need to maintain 20% equity in the home, like any conventional cash-out refinance, but if there’s enough equity, you can also take up to $2,000 in cash for yourself.
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VA cash-out refinance
A VA cash-out refinance is subject to same regulations as all VA loans, so it’s only available to Veterans, Active-Duty Military, National Guard Members, Reserve Members, and certain Surviving Spouses. Your CCM loan officer will work with you to determine if you meet the requirements, including helping you obtain your Certificate of Eligibility (COE). One great advantage of a VA cash-out refinance is that you can borrow up to 100% of your home’s value.
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FHA cash-out refinance
This loan has the same pros and cons as any FHA loan. While the requirements are more flexible than a conventional loan, you’ll have to pay an upfront mortgage insurance premium and monthly mortgage insurance. You can borrow up to 80% of your home’s appraised value, and you don’t have to be refinancing an existing FHA loan. If you can’t meet the credit requirements of a conventional loan, this may be a good choice.
How to get a cash-out refinance
Start by talking to your CCM loan officer to learn your options. You’ll have to complete a mortgage application, and meet the eligibility requirements for the loan you choose. You’ll need to pay for an appraisal to make an accurate determination of your home’s value<6.2 home value estimator>, and there will be closing costs. Be sure to review your mortgage carefully up front, and make sure the benefits outweigh the costs.
Cash-out refinance vs. home equity loan
Another way to access your home equity is with a home equity line of credit (HELOC) or home equity loan, a type of second mortgage. A cash-out refinance replaces your current mortgage with a new one. A HELOC gives you a line of credit to draw on over time, so you pay interest only on the amount you borrow, and you can pay back additional funds to create more borrowing power, too. A home equity loan adds a new mortgage, and gives you a lump sum at closing. If your current mortgage is at a low rate, you may want to consider a HELOC or home equity loan. While their rates may be higher, the amount borrowed will be smaller, so you could save money overall.
Cash-out refinance FAQ
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It may be a good idea. Or it may not. The real question is, does a cash-out refinance make sense for you? It’s a way to unlock the equity in your home and turn it into cash you can use for any purpose you choose. The interest rate is likely to be lower than a credit card or personal loan, but you are using your house as collateral, just as you would with any other mortgage, so paying your mortgage is a must. Talk to your CCM loan officer and crunch the numbers to see if a cash-out refinance is the right loan for you.
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It increases your debt, which could affect your credit score. But it’s a secured loan, backed by your home, so it’s less risky than some other types of debt. As long as you make your mortgage payments on time, you’ll be demonstrating responsible use of credit, which is good for your credit score.
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Just like any other mortgage, you make monthly payments to your lender. Remember, taking cash out doesn’t make your home worth less. The value is still there, so as you repay your loan, you are increasing your home equity, that is, the difference between what you owe on your mortgage and what your home is worth. As your loan goes down, your equity goes up.
