Pros and Cons of a Cash-Out Refinance

With a cash-out refinance, you’ll exchange your old mortgage for a new one with a higher balance, plus your lump sum payment.

Since you’ll have a larger loan balance to pay off using your home as collateral, it’s smart to weigh the pros and cons of cash-out refis to figure out if it’s a good option for you.

What is a cash-out refinance and how do you qualify?

A cash-out refinance swaps your current mortgage for a new one with a different interest rate and terms, plus a larger loan amount. Once closed, you get paid the difference between your new and old loan balance in cash.

Generally, homeowners opt for a cash-out refi to fund a large expense or pay off debt at a lower interest rate.

To qualify, borrowers typically need at least 20% equity in their home (with an appraisal to confirm its value), at least 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, and meet the seasoning requirement of owning your home for a certain amount of time (12 months for a conventional cash-out refi, 12 months of on-time payments for FHA, and 210 days for VA).

Pros and cons of cash-out refinances

Cash-out refinances are a lending product that allows borrowers to leverage their home equity when they need a lump sum of money.

But whether they’re financially prudent depends on your situation and plan for the money. Comparing the positives and negatives can help you get a better sense if a cash-out refi is a good idea for you.

Pros:

• Lowering your mortgage rate: Most borrowers choose to refinance when they can shave down their interest rate and lower their mortgage payment. While cash-out refinances typically have higher rates than rate-and-term refinances, they’re usually lower than personal loan or credit card rates if you need cash fast.
• Access to large sums of money: If you have major expenses or higher-interest debt you’d like to consolidate, cash-out refinances provide an avenue to big funds.
• Potentially boost your credit: If you do use your cash-out to pay off debt, it would reduce your credit utilization and could raise your credit score.
• Simplicity: Because it’s a refinance, you’ll still only have one monthly loan payment. HELOCs and home equity loans are second mortgages.

Cons:

• New mortgage terms: Cash-out refinances replace your old mortgage with new terms, so be sure to understand how that impacts your wallet over the lifetime of that loan.
• Closing costs: Taking out a mortgage comes with closing costs. Closing costs for a cash-out refi average between 2% and 5% of the total loan amount.
• Not instantaneous: Mortgages (even refinances) need to go through the appraisal and underwriting processes, which can take weeks. If you need that money immediately, a cash-out refi might not be the best option.
• Risk of foreclosure: When you take out a mortgage, your house becomes the collateral. If you can’t make the monthly payments, you risk losing it through foreclosure.

The bottom line

Whether a cash-out refinance is a good idea depends on your financial situation, new mortgage terms, and how you use the money.

Be sure to shop for multiple lenders and weigh the pros and cons before committing to a cash-out refi.