Benefits of a cash-out refinance: Is a cash-out refi worth it?

November 18, 2022 - 8 min read

Is a cash-out refinance worth it in 2024?

Cash-out refinancing allows homeowners to turn the equity they’ve built up into cash. A cash-out refi can be a great idea when interest rates are low, allowing you to tap equity and drop your rate at the same time. But when interest rates are higher, a refinance might not make sense.

The good news is that other programs, like a home equity loan or HELOC, can help you cash out equity without refinancing. So explore all your options to find the best cash-out loan for you.

Check your cash-out loan options. Start here

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Benefits of a cash-out refinance

For the right borrower, a cash-out refinance can come with serious benefits. For example:

  • You can use the funds for any purpose. Debt consolidation, home renovations, and home improvements are popular uses
  • You don’t need a specified purpose for the funds; you can even put them toward things like emergency funds and investments
  • You have the option to shorten your loan term or change loan programs when you refinance
  • In a low-rate environment, you could lock in a lower interest rate on your home loan

A cash-out refinance is usually worth it when you can tap home equity and lower your interest rate at the same time. But if refinancing would increase your rate, then an alternative loan type like a second mortgage might be a better option.

Check your cash-out loan options. Start here

Drawbacks of cash-out refinancing

A home loan refinance isn’t the right decision for everyone. Here are some of the downsides that come with cash-out refinancing:

  • Closing costs can be high (typically 2%-5% of the new loan amount)
  • You re-start your mortgage term, usually for another 15 or 30 years
  • If interest rates have risen, you might end up with a higher rate on your full mortgage balance
  • If your home’s value drops, you could owe more on your mortgage than the home is worth

The risks of cash-out refinancing are similar to any mortgage: if the loan defaults, your home is on the line. But there’s a little more to consider here, because with a cash-out refi, your new loan amount is higher than your original mortgage. Your monthly payments could potentially be higher, too.

Cash-out refinance alternatives

If you don’t want to refinance — perhaps because your mortgage rate and monthly payment would go up — then a cash-out refi is not an ideal way to borrow money.

Luckily, there are other ways to access home equity that won’t affect your existing mortgage. A home equity loan or home equity line of credit (HELOC) could be a smart alternative to a cash-out refinance.

Home equity loans

Like a cash-out refi, a home equity loan lets you borrow a large lump sum from the equity in your home. Home equity loans also usually have closing costs in the 2% to 5% range. But you pay those only on the amount you’re borrowing (not the full mortgage amount). So the total cost will be lower. These loans have only slightly higher interest rates than cash-out refinancing.

Meanwhile, home equity loans have another advantage over cash-out refinances. Namely, you don’t reset your existing mortgage term. Unless you opt for a shorter term, refinancing means you end up paying for your house over a longer period.

Suppose you’ve had your home for 10 years, and you refinance to a new 30-year mortgage. You’ll be paying your home down over 40 years. That’s 40 years of paying interest, which isn’t cheap, no matter how low interest rates are. On the other hand, a home equity loan avoids that issue by leaving your original mortgage intact.

Home equity lines of credit (HELOCs)

A HELOC is a bit like a credit card in that you’re given a revolving credit limit and can borrow up to that amount. You pay interest only on your outstanding loan balance and can borrow, repay, and re-borrow as often as you wish over the loan’s draw period.

Like home equity loans, HELOCs are second mortgages. But HELOCs tend to come with low or zero closing costs. So they can be a better way to borrow small sums — or large ones over a brief period. Interest rates are typically variable on these loans and may be higher than home equity loan or refinance rates.

Common uses for a cash-out refinance loan

If you’ve built up enough equity in your home, a cash-out refinance may be worth it. But putting your cash-out funds to good use is an important consideration. Some uses are “better” than others. Here are some of the best uses for your home equity:

  • Consolidate high-interest debt. Debt consolidation can give you a fresh start if you find yourself with high credit card balances or other high-interest debts. Provided you don’t run those debts up again, you could save hundreds each month in interest repayment and transform your personal finances
  • Pay for a home remodel. Many homeowners also use cash-out funds to make home improvements that increase the value of the property and net a bigger profit when they eventually sell. In this way, they see a greater return on their refinance
  • Purchase a rental property. You can also use the lump sum of cash as a down payment on an investment property

In addition, refinancing your home loan allows you to change your current mortgage to one that better suits your financial goals. This may include refinancing a fixed-rate loan to an adjustable-rate mortgage or switching from an FHA loan to a conventional one.

If you need a large sum of money, and you’re also interested in adjusting your loan type, then a cash-out refinance may be an even more attractive borrowing option.

Furthermore, If you did not put a 20% down payment on your conventional loan back when you were a home buyer, then your existing mortgage carries private mortgage insurance (PMI). Another benefit of refinancing is that it could remove PMI and possibly lower your monthly mortgage payment.

Check your cash-out refinance eligibility. Start here

Is a cash-out refinance a good idea?

As a rule of thumb, a cash-out refinance is a good idea if you need cash and you can benefit from refinancing your existing loan.

Whether or not you can get a lower interest rate plays a big role in determining when a cash-out refinance is worth it. For example, if you’re able to fetch a low rate — or one that’s similar to your current rate — then you’ll likely be able to borrow more cheaply than with other types of loans. You may even lower your monthly mortgage payment along the way.

But higher mortgage rates can make a cash-out refinance less attractive — especially for homeowners who already have a lower rate and would increase their mortgage payments and interest costs by refinancing.

When rates are on the rise, it may be better to leave your current mortgage in place and opt for a home equity loan or HELOC. That way you’re paying a higher rate on a smaller loan amount, and you leave your current mortgage intact.

Who is eligible for a cash-out refi?

Pre-housing crash, it was far easier — almost too easy — to cash out home equity. That’s part of the reason these loans sometimes have a bad reputation. But those days are gone. Today, you can expect mortgage lenders to comb through your personal finances before giving you the green light to refinance.

Most lenders have the following minimum requirements for a cash-out refi:

  • You must retain at least 20% equity: That means you can borrow the difference between your mortgage balance and 80% of your home’s market value, which will be re-appraised for the loan
  • You need a credit score of at least 620: The higher your credit score, the better, as you could get approved for a lower mortgage rate
  • You need reliable income and employment: Lenders want to see you can easily afford the new loan’s monthly payments
  • Your DTI is below 43%: Your monthly debt payments (housing costs, credit card debt, student loans, child support, etc.) take up no more than 43% of your gross monthly income. This is your debt-to-income ratio or DTI

Typically, you’ll need to get your home appraised before cashing out equity. Appraisal values can impact the amount of money you can extract from your home’s equity, as they establish a home’s value for the loan-to-value ratio (LTV).

Of course, it’s your job to make sure you can comfortably afford your new loan. But, if you can clear these hurdles, you may well be in good enough financial shape.

Verify your cash-out refinance eligibility. Start here

Benefits of a cash-out finance: FAQ

How does a cash-out refinance work?

A cash-out refinance lets you borrow money against the value of your home by replacing your existing mortgage with a larger one. The new loan pays off your first mortgage, and you keep the difference as a lump sum of cash to use for whatever financial goals you have in mind. This type of loan can offer lower rates because it’s a secured loan, meaning the house is used as collateral. You’ll need to have at least 20 percent equity in your home to qualify.

What is the difference between a cash-out refinance and a regular refinance?

The difference between a cash-out refinance and a normal refinance is that cash-out refinancing allows you to withdraw home equity from your mortgage loan as a lump sum of cash. A regular refinance, or a rate-and-term refinance, simply exchanges your current mortgage loan with a new one that has better terms, preferably a lower mortgage interest rate and lower monthly payment.

Do you have to pay taxes on money from a cash-out refinance?

No. You do not need to pay taxes on money from a cash-out refinance. The IRS does not currently consider the equity withdrawn from your home as income. Rather, it’s considered to be an additional loan, and, therefore, does not need to be reported as income when filing taxes. Keep in mind that this information is provided for educational purposes only. You should always consult with a tax professional for specific details relating to your legal tax obligations.

Explore your options and refinance rates

Cash-out refinancing is safer and more affordable than it was years ago. It’s likely you’ll be able to take cash out no matter what type of mortgage you have. These loans are commonplace for conventional, conforming, FHA, and VA loans. Only USDA loans ban cash-out refinancing.

Of course, while you’re at it, you should fully explore your cash-out loan options. A refinance won’t make sense for everyone. But alternatives, like a HELOC or home equity loan, could be the perfect solution. Connect with a loan officer to find out which loan type is best for you.

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Peter Warden
Authored By: Peter Warden
The Mortgage Reports Editor
Peter Warden has been writing for a decade about mortgages, personal finance, credit cards, and insurance. His work has appeared across a wide range of media. He lives in a small town with his partner of 25 years.