What is a Cash-Out Refinance?
A cash-out refinance is a type of mortgage refinance in which you borrow more than what your house is worth and keep the difference in cash.
Let’s say your home is valued at $225,000, almost the median US home value at the end of March 2019. Let’s also say you’ve paid off $175,000 and wish to make $50,000 worth of home improvements. With a regular rate-and-term refinance, you would refinance only the remaining $50,000 on your mortgage balance. With a cash-out refi, you can refinance for $100,000 and receive the $50,000 difference in cash.
More than 4.9 million homeowners could reduce their interest rate by at least 0.75% by refinancing, according to the Black Knight Mortgage Monitor monthly report for March 2019. The population of “refinanceable borrowers” rose to a 2-hear high at the end of March as average 30-year mortgage rates hit a 14-month low of 4.06%.
Like a rate-and-term refinance, a cash-out refinance enables a homeowner to take out a new mortgage with a lower rate, saving money on future interest payments. A cash-out refinance also offers the benefit of being able to borrow additional funds.
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When Should You Use a Cash-Out Refinance?
In theory, a cash-out refinance may be used to fund any large expense. It could be for home improvement or repair, a child’s college tuition, or paying off credit card debts.
For a couple of reasons, the best use of a cash-out refinance is for home improvement or home-related expenses. First, the amount you cash out gets added to your loan balance, which is secured against your home. Returning to the example we used before, if you refinance a $50,000 loan balance and cash out an additional $50,000, you now owe $100,000. If you use the cash to finance a home improvement, your home should become more valuable—causing your loan-to-value (LTV) to decrease and your financial position to strengthen.
Second, most lenders allow a maximum LTV of 80%, 85%, or 90% on a cash-out refinance, but many allow 100% LTV if the cash is used for home improvements. Let’s use a new example, in which you’ve only paid off $50,000 on a home worth $225,000. In this scenario, your LTV is $175,000 divided by $225,000, which is 77.8%. Assuming a maximum LTV of 80%, your lender will only allow you to increase your balance to $180,000, meaning you can cash out up to $5,000. With the exception for home improvement, you may be able to move your LTV up to 100%, increasing your balance to $225,000 and cashing out $50,000.
Pros of a Cash-Out Refinance
Better rates than unsecured loans. A cash-out refinance typically offers better rates than an unsecured loan, such as a personal loan. Like a regular mortgage, a cash-out refinance involves putting your home up as security. In exchange, lenders are willing to take on more risk, even overlooking less-than-perfect credit.
Added benefit of lower mortgage rate. As mentioned in the section above, millions of American homeowners are in a position to improve their interest rate by refinancing. This rule applies equally to a regular rate-and-term refinance as it does to a cash-out refinance.
Way to improve your financial strength. Using the funds to renovate or remodel your home could increase your home’s value, improving your financial security in the long run.
Cons of a Cash-Out Refinance
Closing costs. There’s no avoiding closing costs, which usually range from 3% to 6% of the loan amount for a refinance. A cash-out refinance usually has higher closing costs than a regular rate-and-term refinance.
Private mortgage insurance. If your LTV goes higher than 80%, your lender will probably require you pay monthly private mortgage insurance (at least until LTV goes back below 80%). PMI costs in the range of 0.5% to 1% of the loan amount each year.
Your home is at risk. A cash-out refinance offers many benefits, but never forget that your home is at risk of foreclosure if you fail to repay the mortgage. Therefore, avoid the temptation to use the funds on unnecessary expenses or anything that is likely to weaken your financial position.
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AmeriSave Mortgage Corporation is a full-service mortgage lender operating in 49 states and DC. Established in Atlanta in 2002, it has funded 220,000+ homes for a total value of more than $55 billion. AmeriSave is known for offering streamlined online applications with the option of contacting customer support any time you need assistance.
Quicken Loans is one of the most reputable mortgage lenders. It offers a large range of mortgage options including refinance loans, FHA, USDA, VA loans, jumbo loans and more.
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Alternative Ways of Borrowing Against Your Home
Also known as a HEL, this is a way of borrowing against your home equity without refinancing. The lender pays the borrower a one-off lump sum, which is added to the borrower’s mortgage balance. As with a cash-out refinance, most lenders allow a maximum LTV of between 80% and 90%. When comparing a cash-out refinance with a home equity loan, ask yourself the following question: Would refinancing still make financial sense if you weren’t taking cash out? If the answer is yes, a cash-out refinance is the right option. If the answer is no, a HEL is a better choice.
Also known as a HELOC, this is exactly like a HEL but with a line of credit rather than a loan. Home owners may withdraw money when they want, up to a pre-determined amount. Only the money withdrawn gets added to the home owner’s mortgage balance.