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Cash-out refinance: The 6 best uses for your cash out funds

Gina Pogol
The Mortgage Reports contributor

A cash-out refinance turns home equity into cash

As home prices appreciate and interest rates hover around historic lows, homeowners can tap their home equity more easily.

With a cash-out refinance, you can typically cash out up to 80% of your home equity.

The funds can be used for anything — from home improvements to debt consolidation — though some uses make a lot more sense than others.

If you qualify for a cash-out refinance and use the money wisely, you could substantially boost your financial portfolio in a short amount of time. 

Verify your eligibility for a cash-out refinance (Oct 24th, 2020)

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How a cash-out refinance works

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

The difference with a cash-out refinance is that your new loan will be for a larger sum than you currently owe on the home.

The difference between your current mortgage and your new one — the “extra” money you’re financing — is the amount you receive as a check at closing. That’s the cash out component.

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

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

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

Lenders typically require the homeowner to leave at least 20% equity in their home, which limits the amount you can withdraw.

How much cash can I take out using 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 $250,000 on your mortgage, you have $100,000 in equity.

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 (also known as the ‘max LTV’).

When you refinance, the new loan (worth $280K) will first be used to pay off your existing loan.

The amount 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.

Verify your eligibility for a cash-out refinance (Oct 24th, 2020)

6 best uses for a cash-out refinance

U.S. homeowners use cash-out refinance loans for many reasons. However, some reasons are “better” and make more financial sense than others.

Most mortgages have very long terms, and the dollars you borrow accrue interest over that 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 to be a good decision. 

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 uses for cash-out refi funds.

1. Complete home improvement projects

Using a cash-out mortgage refinance to fund a home improvement project is typically a good investment.

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.

For most big-ticket renovations, a cash-out refinance can be a good way to finance.

For smaller projects, a home equity loan or line of credit (HELOC) offer lower costs and are often a better option.

Verify your new rate (Oct 24th, 2020)

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 credit card debt.

As a secured loan, a mortgage can offer lower interest rates than the personal loans borrowers often use to consolidate high-interest debt. 

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

A popular refinance strategy for retiring credit card debt involves paying all open credit cards down to zero, then using the monthly savings to reduce the new loan’s active principal balance.

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.

4. Buy an investment property

You could use cash from refinancing your primary residence to buy more real estate, such as a rental or other 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 percent ($50,000). A 5 percent gain on a $500,000 home creates $25,000 in new wealth. That’s a 50 percent return on the original investment.

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

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.

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 percent 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.

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 only lend to you 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.

Verify your eligibility for a cash-out refinance (Oct 24th, 2020)

Other ways to tap your home’s value

A cash-out refinance gives you access to your home equity while also replacing your current mortgage loan with a new one.

There are added benefits to this strategy.

Getting a new mortgage gives you the chance to lower your interest rate, switch to a fixed-rate loan from an adjustable-rate one, or shorten your repayment period.

But what if you want to keep your existing mortgage while also accessing your home’s value? You’ll need another loan product.

Two good options include:

  • A home equity loan — Borrow a lump sum amount from your home equity with home equity loan. You’ll continue making your existing monthly mortgage payments and also add a second monthly payment for the new loan
  • A home equity line of credit — Your home’s value is used to fund a revolving loan you can borrow from as needed, repay, and use again. HELOCs often 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 your existing mortgage that starting over with a new loan wouldn’t make sense.

Do I qualify for a cash-out refinance?

To get cash out of your home, you must have sufficient equity built up.

Each time you make a monthly mortgage payment you add to the value of your home. Plus, as your home appreciates in value, your equity grows with it.

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 percent of your equity alone.

Lenders set these loan-to-value requirements to lower their risk of loss if you default on your new mortgage.

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.  

Credit standards will be a little higher

Your ability to get a cash-out refinance depends on your credit score and debt-to-income ratio just as it would with a first mortgage.

Getting cash out usually requires you to have a credit score of at least 620.

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. But you’d still need to cover a loan origination fee, an appraisal, and attorney’s fees.

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

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

Rising home prices and falling 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.

Verify your new rate (Oct 24th, 2020)

Step by Step Guide

Refinancing a Home