Cash-Out Refinance: The Complete Guide

A Beginners Guide to Cash-Out Refinance and How to Refinance Mortgages

Imagine turning your home’s built-up equity into a stack of cash. For homeowners who have equity in their homes, a cash-out refinance can be a valuable tool to unlock that hidden value. Whether you’re planning a big renovation, consolidating high-interest debt, or just want more financial flexibility, a cash-out refinance provides a path to all of those options. In 2021, the average amount of equity paid out from a cash-out refinance was $60,214, making it a great solution for those looking for extra cash. 

Before making such a large financial decision, understanding the ins and outs of a cash-out refinance is essential. A cash-out refinance involves an overhaul on your current mortgage and making an informed decision can help you stay on track of your financial goals. 

In this complete guide, we’ll walk you through everything you need to know about cash-out refinances. From how they work and what’s required to the pros and cons of refinancing. Keep reading to find out if a cash-out refinance is the right solution for you!

What Is a Cash-Out Refinance?

A cash-out refinance is a mortgage refinancing option where a homeowner replaces their existing mortgage with a new, larger loan. This process involves taking out a new loan that is bigger than the current mortgage balance and receiving the difference in cash, which can be used for a variety of reasons such as home improvements, debt consolidation, or other large expenses. A cash-out refinance is a valuable tool that gives homeowners a chance to access cash while potentially securing better loan terms or interest rates.

How a Cash-Out Refinance Works

When you get a cash-out refinance, the new loan pays off your existing mortgage, and the difference, which represents your home equity, is provided to you in cash. Usually, the maximum loan-to-value (LTV) ratio ranges from 70-75%, depending on the lender and your borrower qualifications. This means you can borrow up to 70-75% of the property’s appraised value. Once you get the cash, you’re free to use it for many different reasons – from property renovations to other investment opportunities. 

Example of a Cash-Out Refinance

Meet Alex and Jamie, a married couple who have owned their home for ten years. Their property, which they originally bought for $300,000, is now valued at $500,000. They currently owe $200,000 on their mortgage, meaning they have $300,000 in equity.

Alex and Jamie decide to pursue a cash-out refinance to access some of this equity for various purposes. They apply for a new mortgage with a loan-to-value (LTV) ratio of 75%. Based on their home’s current value of $500,000, they are eligible to refinance up to 75% of the property’s value, which amounts to $375,000.

The new loan they secure is for $375,000, which pays off their existing mortgage balance of $200,000. This leaves them with $175,000 in cash. They decide to use $100,000 of this cash to renovate their kitchen and upgrade the home’s energy efficiency, which they think will increase the property’s value. The remaining $75,000 is used to consolidate high-interest credit card debt, helping them lower their monthly payments and improve their overall financial situation.

A cash-out refinance has given Alex and Jamie the opportunity to improve their home and streamline their finances, all while securing a new mortgage with a lower interest rate. 

Common Reasons for Getting a Cash-Out Refinance

Getting a cash-out refinance can give you the financial flexibility to cover a wide range of expenses, including: 

• Home Improvements: Funding renovations or upgrades to increase the property’s value and improve living conditions.
• Debt Consolidation: Paying off high-interest debts, such as credit cards or personal loans, to lower overall interest rates and simplify payments.
• Property Investments: Using the cash to purchase additional rental properties or invest in real estate opportunities.
• Educational Expenses: Financing education costs, such as tuition or student loans, for yourself or a loved one.
• Emergency Fund: Creating or replenishing an emergency fund to cover unexpected expenses or financial emergencies.
• Large Purchases: Funding significant purchases, such as a new car or major appliances.
• Medical Expenses: Covering medical or healthcare costs that are not covered by insurance.
• Business Investment: Investing in a business venture or funding business expansion.

While these are all common reasons to get a cash-out refinance, keep in mind that some lenders may place restrictions on what you can use the funds for. It’s important to clarify what you can and cannot use the cash for when you’re shopping around for lenders. 

Types of Cash-Out Refinance Loans

When it comes to refinancing, you have options. Each type of cash-out refinance mortgage has its advantages and potential drawbacks, so it’s essential to evaluate each one to see if it fits with your long-term financial goals. In this section, we’ve outlined the most common types of cash-out refinance mortgages you’re likely to find on the market. 

Non-QM Loan Cash-Out Refinance

Non-QM loans (non-qualified mortgages) aren’t required to follow the same stringent requirements as QM loans (qualified mortgages) and offer more flexibility in terms of credit scores, income documentation, and property types. Non-QM cash-out refinances offer a lifeline for borrowers who may not meet traditional loan criteria, such as self-employed individuals with irregular income or those with less-than-perfect credit. There are several different types of non-QM loans to consider for a cash-out refinance:

• Bank Statement Loan Cash-Out Refinance: A type of loan that uses your bank statements, rather than traditional income documentation like W-2s or pay stubs, to verify income. This option is often used by self-employed individuals or those with irregular income who need to access home equity.
• Profit & Loss Statement (P&L) Loan Cash-Out Refinance: Involves using your business’s profit and loss statements to document income. This is particularly useful for self-employed borrowers or business owners who may not have traditional income documentation but need to refinance and access cash from their home equity.
• Debt-Service Coverage Ratio (DSCR) Cash-Out Refinance: Assesses your ability to cover the new mortgage payments with your property’s rental income. This type of refinance is often used by real estate investors to determine if the property’s income can cover the debt, helping them access cash for further investments or improvements.

Interested in getting a non-QM loan cash-out refinance or want to learn more? Contact us at Defy for a free consultation – we’re happy to help! 

Conventional Loan Cash-Out Refinance

These are standard loans that are not backed by government agencies. Conventional cash-out refinance loans typically offer competitive interest rates and terms, but they usually require higher credit scores and more substantial equity in the property, making it difficult for some borrowers to qualify. If you have a strong credit history and significant home equity, a conventional cash-out refinance could potentially be a good option for you. 

Government-Backed Loan Cash-Out Refinance

These loans are insured or guaranteed by government agencies, which can offer more flexible terms compared to conventional loans. The main options include:

• FHA Cash-Out Refinance: Backed by the Federal Housing Administration, FHA loans often have more lenient credit requirements and lower down payment options. They allow for a higher loan-to-value (LTV) ratio, making them accessible to borrowers with less equity or lower credit scores.
• VA Cash-Out Refinance: Offered by the Department of Veterans Affairs, VA loans are available to eligible veterans and active-duty service members. They typically require no down payment and offer favorable interest rates. The VA also allows for high LTV ratios, making it easier to access significant cash from the property.
• USDA Cash-Out Refinance: Backed by the U.S. Department of Agriculture, USDA loans are designed for rural properties and offer low-interest rates and low down payments. They’re typically less common for cash-out refinancing but can be an option for those with an eligible rural property.

Cash-Out Refinance vs. Rate-and-Term Refinance: What’s the Difference?

A cash-out refinance replaces your existing mortgage with a new, larger loan, allowing you to tap into your home equity and receive the difference in cash. This cash can be used for various purposes like renovations or debt consolidation. On the other hand, a rate-and-term refinance keeps your loan amount the same but replaces your existing loan with new terms, typically focusing on securing a lower interest rate or adjusting the loan term. This can potentially lower your monthly payment or shorten the repayment time frame. So, if you need extra cash, a cash-out refinance is the way to go. But if your goal is to save money on interest or adjust your loan term, a rate-and-term refinance might be a better fit.

How Much Money Can You Get From a Cash-Out Refinance?

The amount of money you can get from a cash-out refinance largely depends on your home’s loan-to-value (LTV) ratio. Lenders typically allow you to borrow up to 70-75% of your home’s appraised value, minus the amount you owe on your existing mortgage. For example, if your home is valued at $500,000 and you owe $300,000, a 75% LTV would let you borrow up to $375,000. This would provide you with $75,000 in cash, minus any closing costs. The exact amount you can get will vary based on the lender’s policies and your borrower qualifications.

Requirements for a Cash-Out Refinance

To qualify for a cash-out refinance, you’ll need to meet several requirements. Generally, you need to have at least 20-30% equity in your property, a good credit score (often 620 or higher), and a stable income to show the lender you can repay the new loan. Afterwards, lenders will order a property appraisal to confirm its current market value and ensure it supports the new loan amount. Lastly, your debt-to-income ratio and overall financial stability will likely be assessed to ensure you meet the lender’s criteria.

Cash-Out Refinance Interest Rates

Interest rates for a cash-out refinance can vary based on factors like your credit score, loan amount, lender policies, and the general market. Typically, cash-out refinance rates are slightly higher than those for a rate-and-term refinance since you’re borrowing more against your home’s equity. However, rates can still be competitive, especially if you have a strong credit score and significant home equity. It’s important to shop around and compare offers from different lenders to find the best rate for your financial situation.

Pros and Cons of Getting a Cash-Out Refinance

Pros:

• Unlocks equity in your investment property
• Enhances cash flow
• Enables diversification of your investment portfolio
• Offers a lower-interest option for debt consolidation
• May provide lower interest rates

Cons:

• Risk of being over-leveraged
• Exposure to market fluctuations if real estate values decline
• Associated closing costs

How to Get a Cash-Out Refinance 

1. Determine Your Financial Goals

Before initiating a cash-out refinance for your investment property, clarify how much cash you need and its intended use. Consider goals such as upgrading the property to enhance value, buying another property to grow your portfolio, paying off personal debt to lower interest rates and improve credit, or setting up an emergency fund. Having a defined purpose for the cash ensures the refinance aligns with your financial strategy and maximizes your property’s equity.

2. Check Your Eligibility

To qualify for a cash-out refinance, you generally need 20-30% equity in your property, with the new loan amount being 70-75% of the home’s appraised value (LTV ratio). Additionally, you should have a credit score of 620 or higher, depending on the lender’s specific requirements.

3. Gather Your Documents

When applying for a cash-out refinance, collect essential documents including: proof of income (W-2s, 1099s, or tax returns), personal or business tax returns from the past two years, current homeowner’s insurance, statements of existing debts, and a copy of your title insurance. Note that specific documentation requirements may vary by lender.

4. Find a Lender

Compare quotes from multiple lenders to secure the best terms, including interest rates, closing costs, and loan conditions. For competitive rates and personalized service, consider Defy Mortgage, where we can guide you through the refinancing process – contact us for a free consultation. 

5. Apply for the Refinance

After evaluating your options, choose the lender that offers the best terms and aligns with your financial objectives. Submit your application along with the required documents, noting that some lenders might request additional information based on their process.

6. The Underwriting Process

Once your application is submitted, the lender will start underwriting to verify all details. They will order an appraisal to assess the property’s market value and your equity, and review all submitted documents to ensure they meet lending criteria.

7. Loan Approval and Closing

After underwriting, you’ll receive the lender’s final decision. If approved, you’ll get a loan disclosure detailing the terms, interest rate, and closing costs. Review these documents carefully, ask any questions, and sign them on closing day to finalize the refinance. You’ll then receive your cash proceeds, minus closing costs.

Cash-Out Refinance Closing Process

The closing process for a cash-out refinance isn’t too different from closing on a new property purchase. After your loan application is approved, you’ll typically enter a waiting period to review loan documents and ensure everything is accurate. Then comes closing day, where you’ll meet with various parties involved in the refinance. The lender will present the final loan agreement outlining the terms, interest rate, and closing costs. Be sure to ask any questions before signing.  Once everything is finalized, the old mortgage will be paid off, and you’ll receive the difference between the new loan amount and your old mortgage balance (minus closing costs) in cash. This can take a few business days to appear in your account.

Cash-Out Refinance Alternatives

A cash-out refinance can be attractive, but it replaces your existing mortgage with a new loan, which means committing to a new interest rate and loan term. It’s crucial to compare rates to ensure that the cash-out refinance offers a lower rate than your current mortgage.

For more flexible access to funds, consider a home equity line of credit (HELOC), which works like a credit card, allowing you to borrow against your home’s equity with a revolving credit limit. Alternatively, a home equity loan provides a lump sum of cash with a fixed interest rate and repayment schedule, enabling you to keep your original mortgage while accessing your home equity.

Should I Get a Cash-Out Refinance?

There’s no one-size-fits-all answer to whether a cash-out refinance is right for you. It depends on your unique financial goals and risk tolerance. Try asking yourself these questions if you’re considering a cash-out refinance:

• Do you have a solid plan for the cash? If you need the money for improvements to your property, debt consolidation, or other investments that align with your long-term goals, it might be a good fit.
• Can you handle a potentially higher loan amount and monthly payment? Cash-out refinances typically increase your debt burden. Make sure your finances can comfortably handle the new payment structure.
• Is your credit score in good shape? A strong credit score (typically 620 or higher) can qualify you for better interest rates, making the refinance more attractive.
• Is the real estate market stable? Avoid a cash-out refinance if property values are declining, as you risk owing more than your property’s worth.

If you’re unsure, consult with a financial advisor to discuss your specific situation and determine if a cash-out refinance is the right path for you.

Cash-Out Refinance FAQs:

1. What is a cash-out refinance?

A cash-out refinance is a mortgage refinancing option where the new loan is larger than the existing mortgage, and the borrower receives the difference in cash. This allows homeowners to convert some of their home equity into cash.

2. Who should get a cash-out refinance?

Those who need funds for home improvements, debt consolidation, or other large expenses and have at least 20% equity in their home should consider a cash-out refinance. It can also be a great option for those looking to secure a lower interest rate on their mortgage. 

3. Is it hard to get a cash-out refinance?

No, it’s not necessarily hard to get a cash-out refinance depending on your financial situation. If you’re not eligible for a conventional loan refinance, there are also plenty of non-QM mortgage options that offer more flexible qualification criteria. 

4. How long does it take to close on a cash-out refinance?

The timeline for closing on a cash-out refinance can vary depending on the lender and the complexity of the loan, but it typically takes 30-45 days after submitting the application. 

5. Where can I get a cash-out refinance?

Cash-out refinance mortgages are available from a wide variety of lenders, including, banks, credit unions, and private mortgage lenders. If you’re looking for cash-out refinance options that are flexible and more customizable, consider a private mortgage lender like Defy. We aim to make home financing more accessible to a wider range of borrowers – contact us today for a free consultation. 

6. What are the requirements for a cash-out refinance?

The exact requirements for a cash-out refinance can vary significantly depending on the lender and the type of loan you choose. Reach out to lenders directly to get a better idea of their specific requirements. However, you should aim to have a credit score of 620 or above and at least 20% equity in your home at the bare minimum. 

7. What credit score do I need for a cash-out refinance?

The minimum credit score required for a cash-out refinance depends on the lender and the type of loan, but a good rule of thumb is to maintain a minimum FICO score of 620. 

8. How much equity do I need to qualify for a cash-out refinance?

Generally, you’ll need at least 20% equity in your property to qualify for a cash-out refinance. 

9. How much money can I get from a cash-out refinance?

The amount of money that you can get from a cash-out refinance depends on a few different factors, such as the appraised value of your home, your home equity, and the lender’s loan-to-value (LTV) ratio limits. 

10. What’s the maximum LTV for a cash-out refinance?

The specific maximum LTV for a cash-out refinance will vary based on the lender’s policies, but typically, it’s 70-75% of your property’s value. 

11. What are the pros and cons of getting a cash-out refinance?

Pros:

• Unlock your home equity in the form of cash
• Secure a potentially lower interest rate
• Can be used to diversify your investment portfolio 
• Can be used for large expenses, such as home repairs
• Can be used to consolidate higher-interest debt at a lower rate

Cons:

• Risk of higher interest rate depending on the market
• Potential of over-leveraging your property
• Closing costs

12. What are the alternatives to a cash-out refinance?

Alternatives to a cash-out refinance include home equity loans and home equity lines of credit (HELOCs). These options also allow you to access your home’s equity without refinancing your entire mortgage.

13. What is the difference between a cash-out refinance and a HELOC?

A cash-out refinance replaces your existing mortgage with a new, larger loan, providing a lump sum of cash, while a HELOC is a revolving line of credit secured by your home, allowing you to borrow as needed. HELOCs typically have variable interest rates, whereas cash-out refinances usually have fixed rates.

14. Is a cash-out refinance the same as a refinance?

A cash-out refinance is a type of refinance where the new loan amount is larger, and the borrower receives the difference in cash. A standard refinance, on the other hand, typically aims to secure a better interest rate or loan term without accessing additional cash.

15. Do you have to own a home to get a cash-out refinance?

Yes, you must own a home to get a cash-out refinance. The loan is secured by the equity in your home, which acts as collateral for the lender.