What you need to know about cash-out refinancing

According to research from Freddie Mac, cash-out refinances accounted for roughly nine out of 10 mortgage refinances in the first half of 2023. With the growing popularity of this type of loan, knowing how a cash-out refinance works can help you determine whether it will benefit you. When you get a cash-out refinance, you replace your mortgage with a larger loan and receive the difference as cash. You can access funds at a relatively low interest rate compared to other financing options, like credit cards or personal loans. But there's also a risk to using your house as collateral and potentially spending more on your mortgage in the long run. 

How a cash-out refinance works

When you refinance your mortgage, you get an entirely new home loan that pays off the existing balance and gives you completely fresh terms, including a new interest rate and repayment term. 

With a cash-out refinance, however, you borrow a larger amount than your outstanding mortgage balance, using your home equity as collateral for the new loan. The new loan pays off your existing mortgage and you get to keep the extra cash, minus any closing costs.

Say your outstanding mortgage balance is $300,000, but your property value is $450,000. That means you have $150,000 in home equity.

Now let's say you getdo a cash-out refinance for $360,000, which is 80% of your home’s value. The new loan would pay off the outstanding mortgage of $300,000 and give you $60,000 in cash. 

Here are the pros and cons of cash-out refinancing that can help you make the final decision:

How to get a cash-out refinance

Here's what to expect throughout the process of applying for and securing a cash-out refinance:

1. Estimate your existing home equity: Get an idea of your current property value so you know how much you could borrow. You can typically borrow up to 80% of your home's value, including the mortgage. Use a cash-out refinance calculator to compare new loan amounts and your updated monthly payment. 
2. Get quotes from multiple lenders: Shop around and get prequalified with multiple lenders to compare your cash-out refinancing options. Consider appraisal fees, interest rates, closing costs, repayment terms, and the average time to close. Prequalifying only involves a soft credit inquiry, which means your credit score won’t be affected.
3. Submit an application with your chosen lender: Be prepared with documents, such as a government-issued photo ID, recent pay stubs and tax returns, and a recent mortgage statement. You may also need to get an appraisal to confirm the value of your home.
4. Go through underwriting and closing: Just like with your original mortgage, your lender will put your application through an underwriting process to confirm your eligibility. Once that's finalized and you sign the proper paperwork, you can close on your loan.
5. Get cash and start new payments: After closing, you'll receive either a check or deposit with your new funds from the cash-out refinance. You'll also start making payments to the new lender.

Cash-out refinance vs. home equity loan vs. HELOC

In addition to a cash-out refinance, you can also access your home equity with a home equity loan or home equity line of credit (HELOC).

Is a cash-out refinance right for you?

Before you decide whether to get a cash-out refinance, consider the benefits and drawbacks. It can be a good choice if you can get a lower interest rate or better terms when you refinance. 

In its October 2023 report, Intercontinental Exchange found that borrowers seeking a cash-out refinance had an average outstanding balance of $165,000. The report also found that most borrowers who refinanced saw their interest rate increase by about two percentage points. Intercontinental Exchange suggested that the increased equity in the home — and the increased funds homeowners could borrow — made it worth the higher interest rate. 

You should also weigh how long you plan to stay in the home. When you refinance, you’ll typically pay closing costs, as you would for a new mortgage. You might not want to refinance and pay large upfront closing costs if you’re planning on moving in the next few years. 

More alternatives to cash-out refinance

Instead of tapping into your home equity, consider other financing options, including:

Personal loans

Personal loans are often unsecured loans, meaning you don’t have to put up an asset, like your car or home, as collateral. Because there’s no collateral to secure the loan, interest rates are usually higher, but the repayment term is usually much shorter (commonly two to five years). That means you may end up spending less on interest, but you'll also probably have a lower loan amount since the payments aren't spread out over a longer period of time. 

Credit cards

Credit cards let you borrow what you need when you need it. You're not paying interest on a lump sum, but you also don't have a fixed repayment period on your outstanding balance. If you only make the minimum payment, it could take a long time to pay off your balance while it keeps accruing interest.

Like a personal loan, credit cards are unsecured. You may not qualify for as large of a credit line as you would with a cash-out refinance, but there's less risk associated with this type of financing.

Cash-out refinance FAQ

What are the downsides to a cash-out refinance?

One primary drawback is that using your home as collateral means you could risk foreclosure if you go into default. Additionally, you could extend the amount of time you're paying a mortgage, increasing interest charges. Even if your monthly payments are lower, that extra time could result in substantially more interest paid overall. 

What are the eligibility requirements for a cash-out refinance?

You'll need a low enough debt-to-income ratio, usually between 43% and 50%. That shows lenders your monthly income is high enough to cover all of your existing debt payments. You’ll also need a decent credit score. Intercontinental Exchange reported that the average score was 715 for borrowers taking out a cash-out refinance in 2023. 

How much money can you get from a cash-out refinance?

Most lenders will allow you to borrow up to 80% of your home’s value. To determine how much you can borrow, you’ll need to get your home appraised to know your home’s current market value.

Once you know the appraised value of your home, subtract your new loan amount from your current mortgage balance to estimate how much cash you’ll receive after closing.

Consider the following example of a $300,000 house with a $200,000 outstanding balance:

• Appraised home value: $300,000
• Maximum loan amount: $240,000
• Mortgage balance: $200,000
• Cash after closing: $40,000