Understanding cash-out refinancing

Quick insights

• A cash-out refinance allows you to take out a new mortgage for more than you currently owe, receiving the difference in cash.
• The cash obtained through a cash-out refinance can be used for numerous purposes such as home improvement, debt consolidation, funding education or investing in additional properties.
• To qualify for a cash-out refinance, you must meet certain criteria including a good credit score, a low debt-to-income ratio and sufficient home equity (typically at least 20%).

Are you looking to tap into the financial potential of your home? A cash-out refinance could be your key to unlocking funds you didn’t even know you had. Imagine transforming the equity in your home into cash that can help you tackle projects like that long-awaited kitchen remodel, consolidate debt to lighten your monthly load or even take a family vacation you’ve been dreaming of. This financial strategy could provide immediate relief while setting you up for future success. In this article, we will dive into how cash-out refinancing works and discover the possibilities it can offer for your financial journey.

What is a cash-out refinance?

A cash-out refinance is a financial process where you take out a new mortgage for more than what you currently owe on your home. The difference is given to the homeowner in cash. Below is an example of what a cash-out refinance could look like:

Example:

• Home value: $400,000
• Current mortgage balance: $250,000
• New mortgage amount: $300,000
• Cash received: $50,000 (the difference)

Benefits:

• You have access to cash for important projects or needs.
• You may be able to secure a potentially lower interest rate on the new mortgage.
• You could increase the value of your home through renovations

This method can help you access the equity in your home while possibly lowering your interest rate.

How does a cash-out refinance work?

A traditional rate and term refinance aims to lower your monthly mortgage payments or change the loan term (e.g., from a 30-year to a 15-year mortgage). With a rate-and-term refinance, you don’t receive cash. With a cash-out refinance, the purpose is to make cash available with a new mortgage. You take out more than you owe on your current mortgage, and the balance is dispersed to you to use as you need.

Let’s say you own a home valued at $500,000 and currently have a mortgage balance of $300,000. This means you have $200,000 in equity, which is the difference between the value of your home and what you owe.

Cash-out refinance process

• Determine the cash amount: Most loan providers allow you to borrow up to 80% of your home’s appraised value. In this case, 80% of $500,000 is $400,000. Subtracting your current mortgage balance of $300,000, you could access $100,000 in cash.
• Application: You apply for a new mortgage of $400,000. This new loan will pay off your existing mortgage and provide you with the cash difference.
• Home appraisal: The lender conducts an appraisal to confirm your home’s value, ensuring it meets the necessary requirements.
• Loan approval: After verifying your income, credit score and the appraisal, the lender approves your new mortgage.
• Closing: At closing, your existing loan is paid off. You receive $100,000 in cash, either via a direct deposit, check or wire transfer.

How much cash can you get?

In this scenario, you could access $100,000 in cash from the difference. The exact amount depends on your home’s equity, the lender’s terms and the current market conditions.

What can you use a cash-out refinance for?

Here are some common uses for a cash-out refinance:

Home improvements

You can use the cash from a refinance to renovate or upgrade your home, such as remodeling a kitchen or adding a bedroom. For instance, you might access $40,000 to modernize your kitchen with new appliances and cabinets, potentially increasing the value of your home.

Debt consolidation

Cash-out refinancing could help you pay off high-interest debts, like credit cards or personal loans, consolidating them into a single mortgage payment at a lower interest rate. For example, you could use $50,000 from the refinance to pay off $20,000 in credit card debt and $30,000 in personal loans, reducing your overall monthly payment.

Education expenses

You can use the funds to cover tuition or other education-related costs for family members, potentially making higher education a little more affordable. For example, a parent might access $40,000 to pay for their child’s college tuition, possibly alleviating the need for student loans.

Emergency fund

You can build or replenish your emergency savings, providing a financial cushion for unexpected expenses like car repairs. For example, using $20,000 to create an emergency fund can help cover unexpected home repairs without adding debt.

Investments

The cash could be used to invest in other opportunities, such as purchasing rental properties or stocks, potentially generating additional income. For example, you might take out $60,000 to buy a rental property, aiming for long-term cash flow and appreciation.

How to qualify for a cash-out refinance

A cash-out refinance carries many of the same requirements as a conventional mortgage or traditional mortgage refinance. Lenders differ, but the common eligibility requirements for a cash-out refinance include:

Good credit score

A healthy credit score demonstrates your ability to responsibly manage your finances and credit. Just like when you applied for your initial mortgage, a cash-out refinance requires a minimum credit score. Exact credit scores vary among lenders and change based on economic conditions. It’s also a good idea to check your credit report for any issues that may cause concern.

Low debt-to-income ratio

Your debt-to-income ratio (DTI) is your monthly debt divided by your monthly income. Lenders use your DTI to determine whether you can reasonably take on additional debt. The lower your DTI, the better chance you have of qualifying for a cash-out refinance. Lender requirements vary, but you should aim to have a DTI of 43% or lower. 

Loan-to-value ratio

Lenders also use your loan-to-value ratio (LTV) to evaluate your eligibility for a cash-out refinance. Your LTV is the comparison of your mortgage amount to the value of your home. Some lenders won’t allow homeowners to exceed an 80% LTV to secure a cash-out refinance. 

Minimum home equity

You need equity in your home before you can secure a cash-out refinance. Equity is the difference between your home's appraised value and how much money you still owe on your mortgage. Homeowners gain equity in one of two ways:

• Paying the principal on your mortgage.
• The value of your home increases.

Lenders want to protect homeowners from owing too much, so many limit the amount you can borrow on a cash-out refinance. A cash-out refinance may require a minimum of 20% home equity, which means you can only refinance up to 80% of the value of your home. VA loans are the exception to the rule. The Veterans Administration allows eligible veterans to refinance up to 100% of the value of their homes.

Pros and cons of a cash-out refinance

Advantages of a cash-out refinance

Homeowners can enjoy many benefits with a cash-out refinance, including:

• Better rates. If interest rates drop or your financial situation has improved, you could qualify for better rates and terms with a cash-out refinance.
• Lower monthly output. Homeowners who use a cash-out refinance for debt consolidation can end up lowering their overall monthly payments. And lower interest rates and a better financial situation may lead to a lower mortgage payment, relieving some financial pressure.
• More cash-on-hand. Cash-out refinances provide you with more liquid cash on hand. Maybe you want to save for college or retirement, do home renovations or buy that big-ticket item you've been thinking about. 

Disadvantages of cash-out refinances

Cash-out refinances do come with some potential disadvantages. These include:

• Too much debt. Sometimes life circumstances can work against homeowners after a cash-out refinance. You risk accumulating debt you can’t afford to pay off, and you risk losing your home.
• Higher payment. It's possible your cash-out refinance results in higher payments than your previous mortgage. You need to make sure the terms of the loan align with your budget.
• Going upside-down. There is a possibility you might owe more than what your home is worth if the value decreases. Many protections exist to help prevent homeowners from owing more than their home is worth, but there is no guarantee.

Alternatives to a cash-out refinance

Here are some alternatives to a cash-out refinance:

• Home Equity Line of Credit (HELOC): This flexible loan allows you to borrow against your home’s equity as needed, with a variable interest rate. You can withdraw funds, pay them back and borrow again during the draw period. Chase does not currently offer Home Equity Lines of Credit (HELOCs) in all states. Please talk with a Home Lending Advisor to see if HELOCs are available in your state.
• Home equity loan: This is a lump-sum loan based on your home’s equity, typically with a fixed interest rate. It’s suitable for those who need a specific amount for a one-time expense. Chase does not offer this loan product.
• Personal loan: Unsecured loans that can be used for different purposes, typically with higher interest rates than secured loans. They don’t require home equity and can be obtained quickly. Chase does not offer this loan product.
• Reverse mortgage: Available to homeowners aged 62 and older, this allows you to convert part of your home equity into cash without monthly repayments. The loan is repaid when you sell the home, move or pass away. Chase does not offer this loan product.

Is a cash-out refinance a good idea?

It depends on your individual financial situation. Evaluate these factors to determine if it aligns with your financial goals:

• Interest rates: If current rates are lower than your existing mortgage, refinancing could lower your monthly payment.
• Purpose of funds: Using cash for high-interest debt consolidation or home improvements can provide a good return on investment.
• Loan terms: Extending your loan term may lower monthly payments but could increase overall interest paid.
• Equity position: Ensure you’re comfortable with the amount of equity you’ll be taking out, as this has the possibility to impact future financial flexibility.
• Closing costs: Consider the closing costs associated with refinancing, as they can offset some of the benefits.

Contact a Home Lending Advisor to learn more about a cash-out refinance and how to get things started.

Cash-out refinance FAQs

How to calculate my home equity?

Determine your home’s current market value by researching recent sales of similar homes in your area or use an online home value estimator. Check your latest mortgage statement or contact your lender for the remaining balance on your mortgage. For example, if your home is worth $300,000 and you owe $200,000 on your mortgage, your home equity would be $100,000.

Does a cash-out refinance require a home appraisal?

Yes, a cash-out refinance typically requires a home appraisal to help determine your home’s current market value. This is used for assessing how much equity you can access.

Do I have to pay taxes on a cash-out refinance?

No, you generally don’t have to pay taxes on the money you receive from a cash-out refinance. The funds are considered a loan, not income, so they are not usually subject to income tax. Please consult with a tax professional for personalized advice.

Are there fees for a cash-out refinance?

Yes, there are fees typically associated with a cash-out refinance. Common fees include closing costs, appraisal fee, origination fee, credit report fee and possibly a prepayment penalty fee.

How long does a cash-out refinance take?

Check with your lender for a more accurate estimate based on your specific situation. A cash-out refinance often takes about 30 to 45 days to complete. However, the timeline can vary.