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 it can let you lock in a lower interest rate on your new mortgage. 

With home values rising year over year and mortgage rates near all-time lows, many homeowners are in a good position to cash 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 (Jun 13th, 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.

With the new loan, you’ll pay off the old loan and then keep the additional cash you didn’t need to pay off the old loan.

The lump sum you keep is your “cash out,” and you can spend it on a variety of financial needs. 

A few important notes on cash-out refinancing: 

  • Cash-out refinance rates are slightly higher than traditional mortgage refinance rates
  • Your rate depends on your credit profile 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
  • Since mortgage rates tend to be lower than personal loan or credit card rates, cash-out refinancing can be a better way to finance larger 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 — like home renovations or consolidating higher-interest debt. 

See a few more good examples of how to use a cash-out refinance here

Verify your cash-out refinance eligibility (Jun 13th, 2021)

How a cash-out refinance works

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

The money remaining, after paying off your original mortgage, is 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 (minus 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 get with a cash-out refi?

For a conventional cash-out refinance, you can take out a new loan for up to 80% of the value of your home. Lenders refer to this percentage as your ‘loan-to-value ratio’ or LTV. 

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 the home is worth $400,000 and the existing loan balance is $250,000.)

But, since the homeowner must leave 20% of the home’s equity untouched, the maximum amount this borrower could withdraw is $70,000. 

If this homeowner already had a second mortgage using the home’s equity — a home equity line of credit, for example — the lender would also subtract that loan’s amount from the available cash-out.

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

Cash-out refinance rates

Interest 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

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

“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 (Jun 13th, 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 — just like homebuyers do when they get a new mortgage.

Requirements for cash-out refinancing vary by lender and type of loan. 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
  • Debt-to-income ratio (including the new loan) of 43% or less
  • Loan-to-value 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 loan cash-out refinances are slightly different, as we explain below. 

Types of cash-out refinance

There are three main cash-out refinance options homeowners can pursue:

  • Conventional loans A conventional cash-out refinance allows you to borrow up to 80% of your home’s value with a minimum credit score of 620
  • FHA loans 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 an annual mortgage insurance fee just like you would on any other new FHA mortgage. A credit score of at least 600 is typically required
  • VA loans 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 the LTV 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 mortgage 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 (Jun 13th, 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.

Cash-out refinancing also gives you a chance to replace an adjustable-rate loan with a fixed-rate mortgage, or to choose a shorter loan term which can reduce your interest payments over time.

And, of course, there’s the cash-out which you’ll receive at closing which could help you get ahead with your personal finances. Upshaw recommends homeowners use their cashed out equity 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 remember: you’re opening a new, long-term loan — likely 15 or 30 years of monthly payments — that you’ll pay lots of interest on even with a low rate. 

That’s why experts recommend cashing out your equity only 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. 

What about debt consolidation loans?

Debt consolidation can be a great way to lower your monthly debt payments and save on interest. But this strategy doesn’t make sense for everyone.

Paying off federal student loans with home equity, for example, may not be the best strategy because you’d lose the repayment flexibility built into student loans.

Paying off auto loans may not be all that smart, either, when you think about it. With a 30-year cash-out refi, for example, you could still be making the monthly mortgage payments in three decades.

That means you’d still be paying off that car loan when the car itself is a distant memory.

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 (Jun 13th, 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 increase the value of your home.

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 already built up in your home. 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 over the past couple years, 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 lower rate on your mortgage. 

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

Verify your new rate (Jun 13th, 2021)