A cash-out refinance helps you pocket money if your home has gained value since you bought it
- With a cash-out refinance, you take out a new home loan for more than the amount you still owe on your home, and you receive part of your home's gained equity in cash.
- Many lenders won't let you take out more than 80% of your home's value in cash.
- Like a home equity loan or HELOC, a cash-out refinance lets you tap into the equity of your home — but it usually comes with a lower rate than a home equity loan or HELOC.
- You should consider additional costs before using a cash-out refinance, including closing fees and private mortgage insurance.
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If you need access to cash to reach big financial goals, there are plenty of ways to access money, such as using a credit card or taking out a personal loan.
And if your home's value has increased since you bought it, you could also access money through a cash-out refinance.
A cash-out refinance comes with lower rates than credit cards or personal loans. It also typically has a lower rate than a home equity loan or HELOC, which are alternative types of home loans for people whose homes have become more valuable.
What is a cash-out refinance?
A cash-out refinance is a mortgage for people whose homes have gained value since they originally purchased it. With a cash-out refinance, you take out a loan larger than the amount you still owe, and you receive a portion of your home's gained value in cash.
With a regular refinance, you take out a loan for how much you still owe on the home with different terms so you can snag a lower interest rate or lower monthly payments.
With a cash-out refinance, you take out a mortgage for more than the amount you still owe so you can use your home's equity for other purposes, such as paying off debt or making home improvements.
How a cash-out refinance works
The amount you're allowed to receive in cash may depend on your lender, but as a general rule of thumb, you can't receive more than 80% of your home's value in cash. This way, you keep at least 20% of your equity in the home.
Let's say your home is valued at $200,000, and you have $100,000 left to pay on your initial mortgage. This means you have $100,000 in home equity, or 50% of the home value.
If you need to keep 20% of your equity in the home, then you're eligible to take out 30% of the value in cash, or $60,000.
You would take out a loan of $160,000 — that's $100,000 that you already owed on the home, and $60,000 in cash.
You'll still pay the additional costs that come with taking out a home loan, including appraisal fees, origination fees, and closing costs.
Should you get a cash-out refinance?
The pros of a cash-out refinance
- You could get a lower rate than you're paying now. Just like with regular refinancing, you might be able to secure a lower interest rate when you use a cash-out refinance. The difference in rates will depend on when you bought your home, though. If you bought the home when rates were high, you'll likely get a better rate now; if you took out your initial mortgage a few months ago, you might not see a significant difference.
- You'll get a lower rate than you would with a home equity loan or HELOC. Home equity loans and HELOCs are two other types of home loans that let you tap into the equity of your home. If you're trying to choose between a cash-out refinance, home equity loan, or HELOC, know that cash-out refinance rates are usually lower.
- You can choose between a fixed and variable rate. Home equity loans come with a fixed rate, and HELOCs usually have a variable rate. With a cash-out refinance, you can choose between a fixed or variable rate.
- You can use the cash for other goals. There are no rules for how you use the money from your cash-out refinance. You may use it to pay off other debts, start a college fund for your children, or make home improvements, for example.
- You might get a tax deduction. If you use the money from your cash-out refinance to make improvements on your home, you may be able to deduct your mortgage payments from your taxes, according to the IRS Publication 96.
The cons of a cash-out refinance
- Your new loan comes with new terms. The new terms of your loan aren't automatically a con — they're just something to look out for. Make sure you understand the new terms of your loan upfront, including things like your term length, interest rate, and monthly payments.
- You might have to get private mortgage insurance. Private mortgage insurance (PMI) is a type of insurance you have to pay if you've paid off less than 20% of your loan. When you bought the home, you may have been able to make a 20% down payment. Or you may have paid off at least 20% of your home value over the years, so you were able to cancel PMI. But if you borrow more than 80% of your home's value, then you'll have to pay PMI again. PMI can cost between 0.2% and 2% of your loan amount in a year. So if you borrow $160,000, you could pay between $320 and $3,200 annually.
- You'll likely pay more in fees than with a HELOC. HELOCs are known as low-fee options for tapping into your home equity. Some lenders don't require origination or closing fees for HELOCs.
- You could be risking foreclosure. If you can't make monthly mortgage payments, you risk your lender foreclosing on your home. Doing a cash-out refinance might result in higher monthly payments, private mortgage insurance, or a higher rate, which could make it harder to make payments. Before you take out cash, consider whether doing so will be a financial strain.
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