How a cash-out refinance works: Rules, rates, and requirements

Erik J. Martin
The Mortgage Reports contributor

Considering a cash-out refinance?

A cash-out refinance has two big benefits. It lets you turn your home equity into cash and lock in a lower interest rate on your mortgage.

With home values rising year over year and mortgage rates near all-time lows, many homeowners are in a good position to consider cashing out their equity.

Whether you opt for a conventional cash-out refi, VA cash-out refinance, or FHA cash-out refinance, you can likely get a great interest rate and put your home equity to work.

Verify your cash-out refinance eligibility (Apr 9th, 2021)

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What is a cash-out refinance?

A cash-out refinance lets you access your home equity and refinance your mortgage at the same time.

When you use a cash-out refinance, your new loan will be larger than what you currently owe on the home. The difference is the amount you’ll receive in cash at closing.

A few important notes on cash-out refinancing:

  • Cash-out refinance rates are slightly higher than traditional refinance rates
  • Your rate depends on your credit and how much cash you take out
  • You can typically cash out up to 80% of your home equity
  • Your new loan will be larger than your old one, so you’ll pay more in mortgage interest in the long run
  • Cash-out refinance rates are one of the lowest-interest forms of borrowing and can be a good way to finance large expenses

There are no rules about how you can or can’t use the funds from a cash-out refinance.

“These additional funds can be used for many purposes, including home improvements, consolidating debt, and other consumer needs or wants,” says Tom Trott, branch manager at Embrace Home Loans.

But because the loan is secured by your home, you typically want to spend your funds on something with a good return on investment.

See a few good uses for your cash-out refinance here.

Verify your cash-out refinance eligibility (Apr 9th, 2021)

How a cash-out refinance works

A cash-out refinance works by taking out a new, larger mortgage loan to pay off your old one.

The funds remaining after paying off your original mortgage are paid to you in the form of a check at closing. This is the “cash-out” component.

Here’s an example of a cash-out refinance works:

  • Home value: $350,000
  • Current mortgage balance: $250,000
  • Refinanced loan balance: $280,000
  • Cash-out at closing: $30,000 (less closing costs)

In the example above, the new loan first has to be used to pay off the existing mortgage.

The remainder of the loan amount — $30,000 — is the sum you’re cashing out.

You’ll also have to pay closing costs on a cash-out refinance, which are usually 3-5% of the loan amount.

The good news is, when you refinance, it’s possible to roll closing costs into your loan balance so you don’t have to pay them upfront.

But rolling closing costs into your loan does mean you’ll pay interest on them over time — so consider the long-term costs before deciding to do so.

How much cash can you take out with a cash-out refi?

For a conventional cash-out refinance, you can take out a new loan for up to 80% of your home’s value.

But remember, you have to subtract the amount you currently owe on your mortgage to calculate the amount you can withdraw as cash.

Here’s an example of how the math works out:

  • Home value: $400,000
  • Max. refinance loan amount (80% of home value): $320,000
  • Current mortgage balance: $250,000
  • Maximum cash-out: $70,000

In the example above, the homeowner starts out with $150,000 in home equity. (Because their home is worth $400,000 and they only owe $250,000 on their mortgage).

But, since they must leave part of their equity untouched, the maximum amount they’re able to withdraw is $70,000.

Lenders limit the amount of equity you can withdraw in this manner because it protects them from losses in case of default.

Cash-out refinance rates

Rates for a cash-out refinance can be anywhere from 0.125% to 0.5% higher than rates for a no-cash-out refinance.

As with all mortgage loans, the rate you’re offered on a cash-out refi will depend on your circumstances.

“The rate you pay will be based on your loan-to-value (LTV) ratio, credit score, and in some cases your loan amount,” says Carol Lynn Upshaw, a senior mortgage originator with Hyperion Mortgage

“The best interest rates are given to those with higher credit scores — typically over 740 — and lower LTV ratios,” she continues.

Also, the more equity you cash out of your home, the higher your interest rate will be.

Ryan Leahy, inside sales manager for Mortgage Network, explains:

“If you borrow 70% of your home’s value, you may pay a rate 0.125% higher. If you borrow 80% of your home’s value, you may end up paying a quarter percent higher rate.”

Find a low cash-out refinance rate (Apr 9th, 2021)

Cash-out refinance requirements

To use a cash-out refinance, you’ll need to qualify for the loan based on your credit, your finances, and your property.

Requirements for cash-out refinancing vary by lender and loan type. But you can generally expect to need:

  • More than 20% equity in your home
  • A new appraisal to verify your home’s value
  • A credit score of at least 620
  • DTI ratio (including the new loan) of 43% or less
  • LTV ratio of 80% or less
  • Verification of your income and employment

These rules apply to most conventional cash-out refinances.

The requirements for FHA and VA cash-out refinances are slightly different, as we explain below.

Types of cash-out refinance

There are three main types of cash-out refinance loans you can pursue:

  • A conventional cash-out refinance allows you to borrow up to 80% of your home’s value with a minimum credit score of 620
  • An FHA cash-out refinance allows you to borrow up to 80% of your home’s value. You’ll have to pay upfront fees that are financed into the loan, as well as a mortgage insurance fee. A credit score of at least 600 is typically required 
  • A VA cash-out refinance (available to veterans, Reserve and National Guard members, active-duty servicemembers, and certain surviving spouses) lets you borrow up to 100% of the home’s value, though many lenders cap it at 90%. You’ll be charged upfront fees that are financed into the loan, unless you are a veteran with a service-related disability

The right type of cash-out refinance loan for you will depend on your current mortgage and what you’re able to qualify for.

The cash-out refinance process

The cash-out refinance process is similar to a traditional refinance:

  1. Check rates from a few lenders to see who can offer you the best cash-out refinance rate and fees
  2. Choose a lender and complete a refinance application
  3. Provide supporting documents, such as pay stubs and W-2 forms
  4. Get a home appraisal
  5. The loan underwriter will review all your documents and approve you for a cash-out refinance
  6. Sign your closing documents and receive the cash-out at closing

“If your property is determined to be of sufficient value to secure the loan, and if the payoff for the prior mortgage is lower than the amount of your new loan, your refi loan will be granted and a mortgage closing will be scheduled,” says real estate attorney Rajeh Saadeh.

Just remember not to skip that first step.

Since cash-out refinance rates are a little higher than standard mortgage rates, and you’re taking out a larger loan than before, it’s extra important to shop around and find your best refinance offer.

Find a low cash-out refinance rate (Apr 9th, 2021)

When is a cash-out refinance the right choice?

“A cash-out refinance loan can be a great idea if you qualify for and can get a lower interest rate on the new loan versus the old loan,” Saadeh says.

It can also be a smart strategy if you need cash that you intend to use responsibly.

Upshaw recommends a cash-out refinance to homeowners who have enough equity built up and plan to use the funds for:

  • Debt consolidation
  • Paying off an existing home equity line of credit
  • Renovating the property
  • Paying income tax bills

There are other smart uses for a cash-out refinance, too — like paying for a college education.

But the thing you need to keep in mind is that you’re opening a new, long-term loan — likely 15 or 30 years — that you’ll pay lots of interest on.

That’s why experts recommend only cashing out your equity if it’s for a serious need or long-term investment, like the ones listed above.

Using home equity for purchases with lower returns — like a vacation or a new car purchase — generally isn’t recommended.

If you’re not sure whether a cash-out refinance makes sense for you, speak with a mortgage lender, broker, or financial advisor who can take a closer look at your finances and advise you on your options.

Explore your cash-out refinance options (Apr 9th, 2021)

Cash-out refinance FAQ

Is a cash-out refinance a good idea?

Yes, if you meet a few basic criteria. You need to have sufficient equity, qualify for a lower interest rate, plan to live in your home for at least three to five years, and a plan to use the cash for worthwhile purposes — such as consolidating high-interest debt or funding a project that will improve your home’s value.

When is a cash-out refinance a bad idea?

A cash-out refinance can be a bad idea if you use the cash as a way to consolidate debt and then run up the debt again. “I advise my clients to pursue a HELOC instead of a cash-out refi if they are looking to have an open line of credit available for emergencies, home improvements, or short-term purchases that they will pay off within a short amount of time,” says Upshaw.

How long does it take to get money from a cash-out refinance?

In a normal market, it typically takes 30 days to close after applying for a cash-out refinance loan. “But due to current rates being so low and the increase in refinance volume, it’s currently often taking between 45 to 60 days to get the money from a cash-out transaction,” cautions Leahy.

How much equity do you need for a cash-out refinance?

You generally need more than 20% equity. But you may be able to get a VA cash-out refinance with less.

Should I pursue a cash-out refinance to pay off debt?

Yes, if your accrued debt charges much higher interest rates than the rate for the cash-out refi loan — such as outstanding credit card debt.

What’s better: a cash-out refinance or home equity loan?

If your current mortgage boasts a low interest rate you’re happy with, and if you only need a relatively small amount of cash, a home equity loan may be a better option than a cash-out refinance. “Home equity loans usually come with lower closing costs and incentives from lenders, as well,” says Trott.

Is it hard to get a cash-out refinance?

So long as you have a decent credit score (above 620), good credit history, stable job security and earnings potential, and sufficient equity built up in your home, you should be able to qualify for and obtain a cash-out refinance.

What credit score do you need for a cash-out refi?

The minimum credit score you need for a cash-out refinance is typically 620. However, FHA and VA cash-out refinance loans might allow a slightly lower credit score. Lenders set their own minimums, so credit requirements can vary depending on where you apply.

Does a cash-out refinance affect your credit score?

Aside from a small ding for having your credit pulled, a cash-out refinance does not affect your credit score. “On the other hand, if the cash-out from the loan is used to pay off debt, you may notice an improvement in your credit score,” Leahy says.

What banks offer cash-out refinancing?

Many brick-and-mortar and online banks and lenders offer cash-out refinance loans, including conventional, FHA, and VA cash-out refinance loans. Shop around carefully and compare rate quotes and terms from several lenders to find the best deal.

What are today’s cash-out refinance rates?

Mortgage rates have fallen, and cash-out refinance rates are no exception.

For a qualified borrower, it’s now possible to cash out your home equity and secure a much lower rate on your mortgage.

Check in with a few different lenders to see what cash-out refinance rates you qualify for today.

Verify your new rate (Apr 9th, 2021)