Cash-out refinance replaces your existing loan with a bigger loan amount and allows converting home equity into cash, potentially reducing your current mortgage interest rate and monthly payments.
Additionally, you can use the cash for home renovations, tuition fees, or debt consolidation. With a cash-out refinance, you can access the funds you need when you need them.
What is a cash-out refinance?
Cash-out refinance is a mortgage loan you opt for based on the home equity you must have built. With cash-out refi, you can refinance your existing mortgage with a higher loan amount and receive the difference in cash.
A conventional cash-out refinance allows using 80% of your home equity, unlike a VA Loan, where the borrower can utilize 100% home equity and 85% in the case of an FHA cash-out refinance.
In a cash-out refinance, you typically pay closing costs on the existing loan amount plus interest on the difference between the existing and the new loan amount.
Cash-out refinances are sometimes referred to as equity refinances or equity-out refinances. However, regardless of the terminology, the general idea remains the same. You are tapping into your home’s equity to use the funds for a large purchase or pay off debt.
What is the difference between Cash-out refinance and No-cash-out refinance?
Cash-out refinance allows homeowners to tap into their home’s equity by borrowing more than they owe and receiving the difference in cash.
A no-cash-out refinance means that the homeowner refinances the mortgage for an amount equal to or less than the existing mortgage balance.
How a cash-out refinance works
Cash-out refinance is an appealing option for many homeowners looking to take advantage of the equity they’ve built in their homes. It’s a way to access the funds you’ve already put into your home by replacing your existing mortgage with a new one.
With a cash-out refinance, you can access the equity you’ve built up in your home and use it for whatever you need. The amount you borrow depends on your home equity and other factors like your credit score and income.
The new mortgage will be for a larger amount (essentially with lower refinance rates and better loan terms) than your existing mortgage, and you’ll receive the difference in cash.
The cash can be used for any purpose, such as paying off credit card debt, making home improvements, or investing.
Cash-out refinance is an efficient way to tap into the funds you’ve already put into your home without taking out a separate loan.
Here are a few of the benefits of a cash-out refinance:
- Tap your home’s equity to use the funds for a big purchase or pay off debt.
- Refinance your mortgage for a lower interest rate.
- Lower your monthly payments.
- Potential to receive lower mortgage insurance rates.
- Lower overall long-term costs with a 30-year fixed-rate loan.
- Likely to receive a lower payment with an interest-only mortgage.
- One-time refinance that doesn’t add to your monthly payments.
- No home appraisal is required for a cash-out refinance.
Eligibility requirements for a cash-out refinance
You must meet a few eligibilities to qualify for a cash-out refi.
Above all, you must own your home as a primary or second mortgage.
You must have an existing mortgage currently being paid off, and the property must be in sound condition.
To start, you need to have a good amount of equity in your home – your homeowner’s loan must be less than 80% of the home’s value.
Secondly, you must have a good credit score – typically, lenders look for a score of at least 620.
Finally, you need to have a steady income. You must show that you have a regular income source and a healthy credit history of making your mortgage payments on time.
If you meet all these requirements, you’re eligible for a cash-out to refinance and can take advantage of its great benefits!
Potential risks of a cash-out refinance
No doubt, a cash-out refinance is a popular choice for homeowners to access their home equity and use it to pay off other debts or fulfil financial requirements.
When you take out a cash-out refinance, you must use the amount you receive to pay off your existing mortgage loan balance. You can use the remaining cash for other purposes, such as home improvements or debt consolidation.
However, the new loan will likely have a higher interest rate than your existing one, meaning your monthly payments will be higher. This could lead to a situation where you cannot keep up with your payments, resulting in foreclosure and losing your home’s equity.
You may also end up owing more than your home is worth if the value of your home decreases and your loan-to-value ratio increases over time.
Another factor to look for is the high closing cost, which consumes your savings increasing overall refinance cost. If you are getting more value than the costs you bear on your new home loan, you can go for it. You must do a cost-benefit analysis before depleting your home equity value.
That being said, if you understand the risks and research before taking out a cash-out refinance, it can be a great way to save money and access the equity in your home.
Read the fine print, understand the terms and conditions, and only borrow what you can afford to repay. Knowing the difference between home equity loans and HELOCs (home equity lines of credit) will also help to determine what type of mortgage loan would be more suitable for your financial need.
Taking the time to weigh the pros and cons can help you make an informed decision and ensure that your cash-out refinance is a smart financial move. If you still need to figure out whether a cash-out refinance right for you, ensure you consult with your mortgage loan expert.