Cash-Out Refinance, From ‘Huh?’ to ‘Ahh!’: A Simple Explainer

Cash-out refinancing (or cash-out refi) is a creative way for homeowners to borrow the money they need for big financial goals.

Allow us to oversimplify for a sec. It’s kind of like using your house as a piggy bank. Except in this case, you’re finally taking out the money you’ve been putting into it (aka your monthly mortgage payments).

It’s true, if you do sell your house someday, you’ll pocket less cash at the time of the sale because you busted into the piggy bank early. But maybe you need the money more right now. 

What Is a Cash-Out Refinance Loan? One Smooth Mortgage Move

A cash-out refinance is a new mortgage loan that lets you partially pocket the difference between how much your house is worth and what you still owe on it. 

The new loan replaces your existing mortgage, pays it off AND pays you back some of the home equity you’ve built up.

Although a cash-out refinance isn’t for everyone (keep reading), it can be a crafty way to pay for something important without busting out your high-interest credit cards.

How Much Equity Can You Cash Out on a Refinance? Most … But Not All

Lenders will usually only let you cash out up to 80% of your home equity. 

Even if you’ve paid off your entire mortgage (congrats!), you can get a cash-out refinance, but you’re still limited to cashing out 80% of your home’s current market value. 

There are exceptions. If you qualify for a Department of Veterans Affairs (VA) cash-out refinance or you’re considering a Federal Housing Administration (FHA) loan, you could get more money.

Exactly how much money you can cash out on a refinance depends on a few things: 

• Your lender’s specific policies
• Your credit score
• The type of mortgage (see below)

Different Mortgage Loans, Different Cash Amounts

The type of new home loan you get to pay off your existing mortgage will factor into how much you can cash out.

Type of mortgage:	How much home equity you may be able to cash out:
Conventional Loan	80%
FHA Loan	85%
VA Loan	100%

What Are Cash-Out Refinances Used For? It’s Up to You

A cash-out refinance can be used for anything. No rules, baby! 

But because your new monthly mortgage payments may go up and be harder to pay each month, you should only cash-out refinance to help improve your overall financial footing.

Here’s what they’re often used for:

• Paying for home improvements that add value to your home
• Paying off high-interest or high-payment debts, like personal loans or student loans 
• Putting more money toward savings for retirement, investing or starting a business
• Getting a car or truck for work (if your mortgage rate is lower than an auto loan rate)
• Funding a child’s education (same as above)

How Does a Cash Out Refinance Work? It’s Déjà Vu

Since you’re essentially getting a new mortgage, the cash-out refinance process works a lot like the mortgage application process. 

Here are the steps for a successful sequel:

1. Check the requirements for a cash-out refi

• Home equity: 30% of your home’s value owned in equity
• Debt-to-income ratio (DTI): Typically the same DTI standards required for a mortgage
• Credit score: A credit score of 620 or higher (verify with your lender)

2. Figure out how much cash you need

People who choose this type of loan often borrow only the amount they need, leaving the rest as home equity.

3. Shop for a lender

Look for the lender who will give you the lowest mortgage rate and fees (and is a legitimate biz). 

You also want to work with a lender who listens and gives you straight answers. Audition them. Throw a bunch of questions their way and see if you like the way they answer.

4. Apply for a cash-out refinance loan

Yep, start downloading those pay stubs. Time to send your lender all the docs they require. Or better yet, choose a lender that can find most of this info for you!

5. Get a home appraisal

The all-important value of your home is calculated during the appraisal, just like when you bought the house.

6. Go through the underwriting process

A tough wait – you remember how it was when you got your mortgage – but your lender will need time to verify your income, debt, details about the house and more.

7. Get approved and close

It’s official. You’ve been approved for a cash-out refinance. Now, it’s time to do your happy dance! You won’t get the thrill of moving into a new house, but if your new mortgage is a good one – with a mortgage payment you can comfortably afford – feel free to throw a small cash-out warming party. 

After closing on your new mortgage, you’ll wait anywhere from a few days to a week for your cash-out amount to be paid out to you.

8. Spend that cash

We know you’ll use it wisely.

What Are the Alternatives? Choose Your Own Adventure

There are other ways to use your home equity to fund something important to you. 

Your available options include:

• Rate/Term Mortgage refinance
• Home equity loan
• Home equity line of credit (HELOC)

A rate/term mortgage refinance won’t give you a lump sum of cash to go and spend. It gives you better terms on your mortgage to help you pay less for it. It may help you free up some money each month.

A home equity loan (also called a second mortgage) is a smaller mortgage you take on in addition to your existing one. It pays you a lump sum, like a cash-out refi.

A HELOC is a line of credit you can pull money from when you need it. It’s like using a credit card, but in this case, your credit limit is a percentage of your home’s equity.

Cash-Out Refi vs. Home Equity Loan vs. HELOC

Loan option	When it might be the best option
Cash-Out Refinance	You need a hefty sum of cash and you want one monthly payment that never changes
Home Equity Loan	You need a smaller amount of cash. You don’t want to mess with the sweet interest rate on your existing mortgage and you don’t mind taking on a second mortgage loan
HELOC	You need money for ongoing expenses (like medical bills) and you can handle monthly payments that will eventually increase after an initial low-cost phase

The most helpful option for you depends on your needs and goals.

Before shopping around for a cash-out refinance, ask your current lender to help you compare refinance options for your unique situation.

What Else? Consider These Key Points Before Cash-Out Refinancing

There’s plenty to consider before refinancing your mortgage. For a cash-out refinance specifically, here’s some food for thought:

Many borrowers are surprised when they can’t take out as much cash as they thought they could.

A cash-out refinance isn’t right for you if you need money today – the process takes some time – but on the plus side, it is a way to avoid piling up your credit card debt.

You’ll pay closing costs that are typically 3% to 6% of the new mortgage. They can be added to the loan instead of paying them upfront, but that means you’ll end up increasing your principal owed.

The more cash you take out of your equity, the bigger your new mortgage and the higher your refinance rate will be. 

When you cash out on home equity, you won’t pocket as much money when you sell your house. That may not matter to you right now, but it’s definitely something to keep in mind.

Refinance rates may change in the time between your lender’s initial estimate and the new loan’s approval, so make sure and ask your lender what it would take to “lock in” your rate.

Yes or No? Only You Can Decide If a Cash-Out Refi Is Right for You

A cash-out refi can be a valid way to borrow some big money.

Mortgage rates are almost always lower than credit card interest rates (and even personal loans), so you could ultimately save money by borrowing with a cash-out refi.

But remember, there are other options. Speak to a lender before breaking into your proverbial piggy bank.