What Is A Cash-Out Refinance?

This article was originally published on July 12, 2021 and updated on August 13, 2024.

Your home is a powerful asset, capable of building significant equity over time. But did you know you can unlock that equity without having to sell your home? Enter the cash-out refinance.

A cash-out refinance lets you replace your existing mortgage with a new one, while tapping into your home’s value to put cash directly in your hands. 

Whether you need extra funds to consolidate debt, finance home improvements, or cover unexpected expenses, a cash-out refinance gives you the flexibility to meet pressing financial needs and achieve your goals.

In this article, we’ll break down what a cash-out refinance is, highlight its benefits, and guide you through the steps to get started. We’ll equip you with the knowledge you need to make informed decisions throughout the process. 

Seattle’s Mortgage Broker is here to help you maximize the benefits of a cash-out refinance and empower your financial future.

What is a Cash-Out Refinance?

We begin with the basics. 

Your mortgage is a loan that covers the value needed to purchase your home. This value accounts for what the home was worth when you purchased it. Over time, as you pay off this mortgage, you build home equity, meaning you own more and more of your home.

That's where refinancing can come in. 

You can apply for a new loan, pay off the existing mortgage, and replace it with the larger one. The defining element of the cash-out refinance loan is that you receive a lump sum amount of cash (the difference between your loan amount and how much you owe on the home) paid to you for you to use however you'd like. 

Currently, FHA cash-out refinance loans can be as much as 80% of the home value, allowing you to turn a sizable portion of your equity into usable cash.

For example, if the original mortgage for your home was $600,000 and through your regular monthly mortgage payments you’ve paid it down to $400,000, you have around $200,000 in home equity, depending on the current value of your home. If you decide to go for a cash-out refinance, you can get a new loan for $480,000 with $80,000 as a lump sum before closing costs. 

In this sense, a cash-out refinance is like a home equity loan.

Why Use Cash-out Refinancing?

Cash-out refinancing gives homeowners a flexible way to tap into the value of their homes and use that money for all sorts of purposes. 

Here are some of the primary reasons why cash-out refinancing might be worth considering:

Access to Cash

It provides you with a lump sum of money that you can use for home improvements, paying for education, medical expenses, or even funding a major purchase. It allows you to access your home equity without having to sell your property.

Debt Consolidation

If you have high-interest debt, such as credit cards or personal loans, a cash-out refinance can help you consolidate those debts into one lower-interest mortgage payment. This can make it easier to manage your finances and potentially save you money on interest over time.

Home Improvements

Many homeowners use cash-out refinancing to fund renovations or upgrades. By improving your home, you may increase its value, which could be beneficial if you decide to sell in the future.

Potential Tax Benefits

In some cases, the interest on your mortgage may be tax-deductible, especially if the funds are used for home improvements. This can provide additional financial savings, though it’s important to consult with a tax advisor to understand your specific situation.

Lower Interest Rates

If interest rates have dropped since you took out your original mortgage, a cash-out refinance might allow you to secure a lower rate, which could reduce your monthly mortgage payments or the overall cost of the loan.

Flexible Use of Funds

Unlike some other types of loans, there are no restrictions on how you can use the cash you receive. This flexibility makes it a versatile option for addressing a variety of financial needs. But it also carries some risk.

Since a cash-out refinance uses your home as collateral, you want to be careful how you use your funds. Ensure you’re making this decision to position yourself for a better financial future.

Avoiding Other High-Cost Loans

A cash-out refinance might be a better option than taking out a personal loan or using high-interest credit cards, as mortgage rates are generally lower than other types of debt. When refinancing is done the right way, a mortgage refinance can get you a lower interest rate and reduce your monthly payments.

A cash-out refinance is a good decision for many homeowners, but it's not for everyone. This is where working with an expert is the best idea. You're going to want to make sure that the timing and deal makes the most sense for your financial situation.

How Does a Cash-Out Refinance Work?

As described above, a cash-out refinance is a type of mortgage refinancing where you take out a new loan for more than what you owe on your current mortgage. 

The difference between the refinanced loan amount and your owing mortgage balance is given to you in cash, which you can then use for whatever you need. 

Here are the steps for a cash-out refinance loan.

1. Assess Your Home Equity

Your home equity is the difference between your home’s current market value and the remaining balance on your mortgage. For example, if your home is worth $300,000 and you owe $200,000, you have $100,000 in equity.

2. Determine the Loan Amount

Lenders typically allow you to borrow up to a certain percentage of your home’s equity, often around 80%. So, if you have $100,000 in equity, you might be able to borrow up to $80,000 in a cash-out refinance. As a type of home equity loan, a cash-out refinance allows you to use your home value to your financial benefit.

3. Apply for the New Loan

You apply for a new mortgage that is higher than your current mortgage balance. The new loan pays off your original mortgage, and you receive the difference in cash. Using our previous example, if you owe $200,000 and you take out a $280,000 loan, you get $80,000 in cash.

4. Use the Cash

Once the refinance is complete, you can use the cash for any purpose, such as home renovations, paying off high-interest debts, funding education, or other financial goals.

5. Repay the New Mortgage

Your new mortgage will have different terms, which could include a different interest rate, monthly payments, and repayment period. You’ll make payments on this new loan just as you did on your original mortgage.

Homeowners can use cash-out refinances to tap into home equity and turn it into cash, while also possibly securing better loan terms in the process. However, it’s important to carefully consider these new loan terms and your ability to repay the higher mortgage amount.

Is it Too Good to be True?

A cash-out refinance isn't for everyone. There are plenty of pros and cons to a cash-out refinance that you must assess before applying. 

That’s why we always recommend that anyone considering a cash-out refinance speak with an expert before going ahead with plans to refinance.

Cash-Out Refinancing Pros

When you're approved for a cash-out refinance, you'll see some benefits beyond the cash payment.

Improve Your Credit Score

If you use your funds to pay off high-interest rate credit cards or eliminate other debt, you'll probably see an improvement in your credit score. This is an excellent use for cash-out refinance funds. 

Lower Interest Rates

There’s no denying that interest rates are significantly higher today than they were three or more years ago. However, depending on when you bought your home, your specific interest rate may be lower now or  in the near future. If that is the case, a refinanced rate will save you some money from interest on the loan. 

Tax Deductions

Your newly refinanced loan may come with tax-deductible mortgage interest. 

Improve Your Home's Value

If you use your cashed-out funds to make a thoughtful upgrade to your home, you'll improve your home's value. When it comes time to sell the house, down the road, you're more likely to recover more of your investment. 

When used the right way, your cash-out refinance can help you experience financial benefits.

Cash-Out Refinancing Cons

As with any financial decision, there are some points to consider before signing on the dotted line.

Perpetuating Bad Habits

Don't use a cash-out refinance to support bad spending habits. Digging yourself out of one mountain of debt with your cashed-out amount, only to build another mountain, is one big reason not to go for a cash-out refinance. Remove debt that's a burden, then work hard to stay debt-free.

Closing Costs

As with any mortgage, you'll pay closing costs again when refinancing your home loan. This amount can be financed and rolled into your monthly payment, but be sure the closing costs are worth any savings you hope to gain from the refinance. 

New Loan Terms

Be sure you are familiar with the new terms of your loan before you finalize it. Chances are, the terms are different from your original mortgage, even if it is the same mortgage lender. Review payment due dates, rates, fees, early payment penalties, and the new length of your loan. 

Private Mortgage Insurance

Unless you're refinancing to less than 80% of your home's value, your refinanced loan may include private mortgage insurance. 

It's important to understand the reasons for refinancing your home with a cash-out option before you go through the process of approval and ultimately close on a new mortgage. Your cashed-out amount should not be considered spending money. Use the funds to add value to your home, strengthen your overall financial position, or relieve overwhelming debt.

What Else Do I Need to Know?

As with other loans, there are cash-out refinance requirements you must meet and other considerations you have to look at. 

Not every homeowner qualifies for this type of plan to refinance, and not every home is a good candidate. Be sure you do your research to know what to expect with the cash-out refinance rules specific to your unique situation. 

Here are some of the main questions to ask yourself when considering a cash-out refinance loan.

How much equity do I have in the home? 

In general, your home can qualify for a cash-out refinance if you have at least 20% equity. 

How much can I borrow? 

The refinanced amount will pay off the original remaining loan amount plus give you the remaining amount in cash. 80% of your property value is a could number, while retaining a good equity cushion. Though there are some loan programs which may allow you to borrow up to 150% of your home's value. 

What are the risks? 

As with your initial mortgage on your home, if you fail to make payments on your refinanced loan, the lender can foreclose on your home. Be sure you really need that cash payment, and you have a good use for it before you consider a refinance that could increase your monthly mortgage payments. 

What kind of loans qualify for cash-out refinancing? 

You can refinance any existing loan, including FHA, VA and conventional, and whether you have a fixed-rate mortgage or an adjustable-rate mortgage.

Any type of mortgage is a big financial decision. When considering a cash-out refinance, factor in the details of the new loan along with the goals you have for this type of refinance.

How Does a Cash-Out Refinance Impact Monthly Payments?

A cash-out refinance can have a significant impact on your monthly mortgage payments. 

When you refinance your mortgage and take out a larger loan to access your home’s equity, your new loan amount will typically be higher than your previous balance.

This increase in the loan amount means that, depending on the interest rates and term of the new mortgage, your monthly payments could be higher than what you are paying on your current mortgage. However, if you secure a lower interest rate or extend the term of your mortgage, you might offset some of the increase, potentially keeping your payments manageable.

It’s also important to consider that while your monthly payments might rise, a cash-out refinance could improve your overall financial situation. 

For instance, if you use the cash to pay off high-interest debt, the savings from lower interest payments on that debt might outweigh the increase in your mortgage payment. Additionally, using the funds for home improvements could boost your property’s value, potentially leading to long-term financial benefits. 

Ultimately, you must weigh the impact on your monthly budget and ensure that the new payment aligns with your financial goals.

Myth Busting: Cash-Out Refinancing is Not a HELOC (Home Equity Line of Credit)

Though both a cash-out refinance and a home equity line of credit are types of home equity loans, a cash-out refinance is different than a HELOC). Yes, both loans let you tap into your home’s equity for funds, but they work in different ways.

A cash-out refinance gives you a lump sum of money all at once, whereas a HELOC offers a revolving line of credit that you can draw from as needed. With a HELOC, you don’t get a single payout; instead, you can borrow money up to a certain limit whenever you need it as a line of credit.

HELOCs usually come with specific timeframes during which you can withdraw funds, and you’ll need to repay whatever you borrow, often at a variable interest rate. They’re typically set up as a second mortgage, unlike a cash-out refinance, which replaces your mortgage with a new one. 

In some cases, you can refinance your mortgage and replace it with a HELOC, but this is usually only an option for smaller loan amounts.

What Do I Need For a Cash-Out Refinance Loan?

The process of applying for a cash-out refinance loan requires many of the same documents you gathered for your original mortgage, but it’s crucial that all information accurately reflects your current financial situation. 

Be sure to have the following documents ready:

• Tax returns and W-2s and/or 1099s
• Recent pay stubs
• Photo ID
• Your current mortgage paperwork
• Property survey
• Proof of any home improvements
• Title insurance
• Two months of bank statements

When you meet with your mortgage broker, don’t hesitate to ask questions. It’s important to fully understand the cash-out refinance process before committing to a new loan.

When Is the Best Time for a Cash-Out Refinance?

The ideal time for a cash-out refinance is when your home equity has significantly increased. For example, in markets like Seattle, where real estate continues to be booming, now could be a great time to tap into your home’s value. Remember, you can consider a cash-out refinance like a home equity loan.

It's important to note that interest rates have risen significantly over the last few years, meaning that if you secured a low rate during the historic lows of 2020 and 2021, you're unlikely to get the same rate in today's market. 

Before pursuing a cash-out refinance, carefully consider whether the benefits of accessing your home’s equity outweigh the potential increase in your mortgage rate. Refinancing could still be a smart move, but it's crucial to factor in the current higher rates and how they will impact your overall financial picture.

Another key factor is ensuring the financial benefits outweigh the costs before you plan to sell the home. If the refinancing costs can be recovered within 24 months and you intend to stay in the home for at least five years, it’s a smart move. 

Additionally, refinancing makes the most sense when you’re in a strong borrowing position—meaning your equity is high, you’ve had stable employment in the same field for at least two years, and you have a cushion of at least two months' worth of mortgage payments in the bank. 

Avoid waiting until you’re struggling with payments, as refinancing is more beneficial when you’re financially stable.

Interested in Cash-Out Refinancing?

There are many considerations to make when looking at a cash-out refinance—which is why it’s always best to consult with an experienced mortgage broker. 

Whether you're looking to consolidate debt, fund home improvements, or simply access extra cash, Seattle’s Mortgage Broker is here to guide you through the process and ensure you make the right financial decisions for your future.

Contact Seattle’s Mortgage Broker today to explore your options and see how cash-out refinancing can help you achieve your financial goals.