Cash-out refinance examples: How to use your home equity

Gina Freeman
Gina Freeman
The Mortgage Reports Contributor
June 4, 2021 - 10 min read

A cash-out refinance turns home equity into cash

As home prices rise and interest rates remain near historic lows, homeowners can refinance and tap their home equity more easily.

Cash-out refinancing typically lets you withdraw up to 80% of your home equity.

You can use the cash for anything — from home improvements to debt consolidation — though some uses make more sense than others.

If you qualify for cash-out refinancing and use the money wisely, you could seriously boost your financial portfolio.

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>Related: Explore cash-out refinance options

How a cash-out refinance works

Like other refinance programs, a cash-out refinance replaces your existing home loan with a new home loan, typically at a lower interest rate.

The difference with a cash-out refinance is that your new loan will have a higher balance than you currently owe on the home.

With money from the new, larger loan, you’ll pay off your existing mortgage lender. Then, you’ll keep the additional cash from the new loan for yourself. This leftover money is your “cash out.”

Here’s an example of what cash-out refinancing might look like:

  • Current mortgage balance: $250,000
  • Refinanced loan balance: $280,000
  • Cash-out: $30,000 (minus closing costs)

Keep in mind you can’t withdraw all your equity using a cash-out refinance.

Lenders typically require homeowners to leave at least 20% equity in their homes, which limits the amount you can cash out.

How much cash can I get with a cash-out refi?

The amount you can cash out depends on your home’s value and your current loan balance.

The refinanced loan amount typically maxes out at 80% of the home’s value (though some VA cash-out loans allow up to 100% financing).

For example, if your home is worth $350,000, and you owe only $250,000 on your original mortgage, you have $100,000 in equity. This example assumes you don’t have a second mortgage.

But you won’t be able to get a $100,000 check at closing.

First, a lender will calculate 80% of the home’s value — in this case, $280,000. That’s the maximum loan amount for your refinanced mortgage. This is also known as the ‘max loan-to-value ratio (LTV).’

When you refinance, the new loan (worth $280,000) will pay off your existing $250,000 loan balance.

The amount of equity leftover, which in this case comes out to $30,000, is the most you can take out using a cash-out refinance.

But don’t forget about closing costs. If you have $5,000 in closing costs, your final check will be $25,000. Still a valuable asset, but only a quarter of the $100,000 you’ve built up in home equity.

6 cash-out refinance examples

How should you use your cashed-out equity?

U.S. homeowners use cash-out refinance loans for many reasons, and there are no rules for how to use the money. However, some uses are “better” and make more financial sense than others.

Most mortgages have very long loan terms, and the dollars you borrow accrue interest over this entire repayment period.

So using this long-term debt to finance short-term needs isn’t a great idea.

For example, most finance professionals wouldn’t consider using a 30-year mortgage to finance an extravagant vacation. You’d be paying back off the vacation for decades.

You should also think twice before using a cash-out refi to buy a car, because you could be paying interest on the car for 30 years. You could still be paying interest on the vehicle long after you’d sold it.

With that said, here are some of the best examples of how to use cash-out refinancing funds.

1. Complete home improvement projects

Using cash-out mortgage refinancing to fund a home improvement project should be a good investment for most homeowners.

Adding a master bedroom suite to your home could cost $100,000 or more; remodeling a kitchen could run $60,000 or more; and, remodeling a bathroom may cost $50,000 or more.

But these projects also add to the value of your home — meaning you’re enhancing your real estate investment and not just spending money.

Cash-out refinancing can be a good way to pay for these big-ticket home renovations.

For smaller projects, a home equity loan or a line of credit (HELOC) may offer better solutions. With these loans you keep your original mortgage in place and use a separate, smaller loan to tap into your home equity.

2. Pay off high-interest credit card debt

Cash-out refinance loans can be powerful tools when you need to pay off a lot of lingering, high-interest debt like credit card accounts or personal loans.

Because it’s a secured loan, a mortgage can offer lower interest rates than the personal loans borrowers often use to pay off existing debt that charges higher interest rates.

Credit card debt can accumulate interest at rates higher than 20% while mortgage debt may cost you only 3% to 5%. There’s a lot of interest to be saved there — and your monthly payments can come way down, too.

Here’s a popular refinance strategy for eliminating credit card debt:

  1. Use cash-out refinance money to pay off all open credit cards
  2. Use the money you were paying on credit card debt to pay down the mortgage loan’s principal balance each month — in addition to making the regular mortgage payment

In this way, homeowners can save hundreds — sometimes thousands — of dollars while reducing their overall debt load. And with this strategy you’d gain momentum every month as your balance declines more and more.

The process is called debt consolidation. It works only if you keep credit card balances low in the future after paying them off.

We don’t recommend this strategy for student loan debt since you have other affordable options for refinancing student debt — and because federal student loans have flexible repayment options a new mortgage can’t offer.

3. Add to or protect your existing investments

A cash-out refinance can also enhance your investment portfolio.

Many investments pay better returns than the cost of borrowing against your home.

If you need cash and don’t want to sell existing investments — for example, in a down market or with an investment that contains a penalty, like retirement savings or CDs — tapping your home equity might be a cheaper option.

Some investment products can also help you save money on your income taxes. Putting money in an IRA or a 529 College Savings plan can lower your taxable income up to a point.

A cash-out refinance can help you diversify your holdings, too, or protect against a housing market downturn.

However, investments that pay higher than mortgage interest rates are typically riskier than fixed or guaranteed income products.

Before trying out this strategy, review your plans with a trusted financial planner so you can make sure you take advantage of tax deductions while also planning for the future.

4. Buy an investment property

You could use cash from refinancing your primary residence to buy more real estate, such as a rental or investment property.

As an asset class, real estate can build wealth quickly because you can leverage your purchase.

For instance, you could control $500,000 of real estate with a down payment of 10% ($50,000). A 5% gain on a $500,000 home creates $25,000 in new wealth. That would create a 50% return on the original cash investment (your $50,000 down payment).

By contrast, a 5% gain on $50,000 in stocks creates just $2,500 in new wealth.

This is a great way to expand your real estate portfolio.

In many cases, homeowners take a cash-out loan on their home and buy a rental property with cash.

When they want to invest again, they do a cash-out refinance on their existing investment property to buy another one. The result is a robust collection of rentals that produce ongoing income and tend to hold their value historically.

5. Buy a second home

If you’re not into being a landlord, but you do want another home, you can cash-out your primary residence to buy a second home (vacation property).

With as little as 10% down, you can purchase a vacation spot for your family. No booking hassles, no sky-high hotel prices — plus you may later decide to rent out the new home for income when you’re not using it.

Today’s home values are high, making it easier to raise enough down payment cash to buy a second home.

Of course, vacation home prices are rising, too.

If your cash-out refinance can’t generate enough cash to buy a second home, shoot for a 20% down payment on the new home so you won’t have to pay private mortgage insurance (PMI) premiums.

And remember, FHA loans and VA loans won’t finance a vacation home, so you’ll need a conventional mortgage.

6. Protect a business against cash-flow emergencies

If you have an existing business or a start-up, a cash-out refinance can serve as a cheap source of emergency capital.

Have you heard the saying that banks lend to you only when you don’t need a loan? There’s some truth in that old saying.

So it may be smart to cash out your equity before your business experiences any cash flow glitches and threatens your eligibility to borrow cash.

Your interest rate is also likely to be better when your financial situation is intact, your income stable, and your credit score acceptable.

Other ways to tap your home’s value

Cash-out refinancing gives you access to your home equity while also replacing your current mortgage loan with a new loan.

There are added benefits to this strategy.

Your new loan could have a shorter loan term, a lower interest rate, or a fixed rate if your existing mortgage still has an adjustable-rate.

Shorter, fixed loan terms could save thousands in interest payments over the life of the loan — if you can afford the higher monthly payment.

But what if you already have a really good fixed interest rate and don’t want to change your loan term?

Can you tap home equity while keeping your existing loan and paying it off as scheduled?

Yes. Here are two good ways to get this done:

  • A home equity loan: You can borrow a lump sum amount from your home equity with a home equity loan. You’ll keep making your existing monthly mortgage payments and also add a second monthly payment for the new loan
  • A home equity line of credit: Your available home equity can fund a revolving loan that you can borrow from as needed, repay, and use again. HELOCs usually have variable interest rates

These types of loans make sense when you already have a competitive interest rate loan for your home — or when you’re so far into repaying your existing mortgage that starting over with a new loan wouldn’t make sense.

Loan amortization schedules require higher interest payments in the earliest years of a loan’s term. If you’re 15 years into a 30-year loan, you may have already repaid most of the loan’s interest.

So starting a new amortization schedule on a mortgage refinance could cost more than sticking with your original mortgage — even if you get a lower rate on the new loan.

In this case, a home equity loan or line of credit might work well.

Do I qualify for a cash-out refinance?

To get cash out of your home, you’ll need to:

  • Have sufficient equity built up in your home
  • Qualify for a cash-out refinancing loan
  • Pay closing costs

Let’s look at these three criteria separately.

Do I have enough home equity?

Each time you make a monthly mortgage payment you add to the equity in your home. Simultaneously, home value appreciation adds to your equity.

If you owe $100,000 on a home that’s worth $200,000, you have $100,000 in equity.

But, this doesn’t mean you could get this entire $100,000 in cash out of your home. Both conventional and FHA cash-out loans require you to leave at least 20% of your equity. That’s $40,000 on a $200,000 home you can’t cash out.

This means you could borrow up to $60,000 minus closing costs.

Leaving 20% in equity can limit borrowers who already have two mortgages on their homes. For example, let’s revisit the scenario above — your $200,000 home on which you owe only $100,000.

After leaving the 20% ($40,000) in equity alone, you’d have $60,000 in equity left to borrow against. But if you also have a $40,000 home equity line of credit, your cash-out refinance could tap only $20,000 minus closing costs.

Lenders set these loan-to-value ratio requirements to lower their risk if you default on your new mortgage. If the bank had to start foreclosure proceedings, that 20% of equity in your home could absorb a lot of the bank’s losses.

Only a VA cash-out loan, open to veterans and active duty military members, could let you access all of your equity while replacing your first mortgage.

Do I qualify for cash-out refinancing?

Your ability to get approved depends a lot on your credit score and debt-to-income ratio.

Credit requirements tend to be more stringent for cash-out refinances compared to original mortgage loans. Some lenders allow FICO scores starting at 620, but others may require 640, 660, or higher.

You’ll also need a new home appraisal to verify the home’s current value is enough to support the cash out loan. And you must have steady income and employment.

Check with your loan officer if you have questions about your ability to borrow or repay the loan.

What about closing costs?

Just like with your first mortgage, a cash-out refinance loan requires you to pay closing costs.

Since your property won’t be changing hands, the costs may not be quite as high as your original mortgage’s costs. But you’d still need to cover a loan origination fee, an appraisal, and attorney’s fees.

You could potentially finance these costs into your new mortgage loan, but this means you’ll pay more interest in the long run.

Many borrowers plan to use part of their cash-out to cover closing costs, but this has the same net effect as rolling the costs into the new loan.

What are today’s cash-out refinance mortgage rates?

Rising home prices and low mortgage rates put homeowners in a good place to cash out their equity.

If you can take cash out of your home for a good purpose, and lower your interest rate at the same time, you can really put your equity to work.

Check rates and loan options from a few lenders to see whether cashing out is an option for you.

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