What Is a Cash-Out Refinance and Who Qualifies?

If you’re a homeowner in need of money, a cash-out refinance could be a beneficial option.

A cash-out refi gives you access to money by replacing your current mortgage with a new, larger loan by tapping into your home equity. At closing, you get the difference between your new loan amount and old one in a lump sum payout.

But does that money come with restrictions and who qualifies for cash-out refinancing?

What is a cash-out refinancing?

A cash-out refinance replaces your current mortgage with a new rate and terms, plus a larger loan amount. It then pays you the difference between your new and old loan balance in cash. For comparison, a standard mortgage refinance keeps your loan balance but changes your rate and terms.

Generally, homeowners opt for a cash-out refi in order to finance something for their home or pay off other expenses or debt at a lower interest rate than the typical credit card. But there are no restrictions for what you put the money towards. But since you’ll be paying a larger mortgage amount with different terms, it’s important to figure out if the juice is worth the squeeze before

How much cash you’re able to pull out depends on your property value, your current loan balance, and some lender guidelines.

Requirements for a cash-out refinance

Just like applying for a new mortgage, qualifying for a cash-out refinance is based on your income, credit score, and property value. Additional requirements vary by lender (which you should always shop around for) and cash-out loan type.

Most commonly, borrowers should expect to need at least 20% equity in their home and an appraisal to confirm its current value. Typically, you’ll also need to meet the floors of a 620 credit score, a debt-to-income ratio below 43% (which includes your new monthly mortgage payment), and a loan-to-value ratio below 80%. You’ll also need proof of your income and employment.

Regardless of your equity stake, you must also hit the seasoning requirement: needing 12 months of homeownership to become eligible for a conventional cash-out refi, 12 months of on-time payments for an FHA cash-out refi, and 210 days for a VA cash-out refi.

How to evaluate your cash-out refinance

First, determine your home equity by subtracting your loan balance from your property’s current market value (not the purchase price). If your house is now worth $500,000 and $200,000 remains on your mortgage, you have $300,000 in equity.

You can figure out your maximum cash-out by calculating 80% of your home’s value. For the example above, that would come to $400,000 ($500,000 x .8). Then you subtract your current mortgage balance to get $200,000 ($400,000 - $200,000) as your max lump sum payout (minus closing costs and fees).

Shop around for interest rates from multiple lenders because it could potentially save you thousands of dollars over the lifetime of your loan. Once you get the quoted rate you’re happy with, calculate and budget your new monthly mortgage payment and see if it makes financial sense. If it doesn’t, look into alternatives like a HELOC or home equity loan.

After submitting your application, you’ll go through the appraisal and underwriting processes before the loan can be closed and you receive your payout.

Does a cash-out refinance make sense?

Whether a cash-out refinance is a good idea depends on the borrower’s situation, mortgage terms, and intentions for the money.

It can also make sense if you qualify for a lower interest rate than your original mortgage to reduce monthly payments, or you’re switching from an adjustable-rate to a fixed-rate.