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How a Cash-Out Refinance Works

How a Cash-Out Refinance Works

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

    A cash-out refinance enables you to refinance your existing mortgage and access the equity in your home with a single loan.  For example, you can refinance your mortgage and take money out of your home to pay for a major expense such as college tuition, home renovations, a vacation or any number of purposes.  With a cash-out refinance your new loan amount is greater than the principal balance of your existing mortgage.  The borrower keeps the difference between the amount of the new mortgage and the principal balance of the existing mortgage, less closing costs.

    For example, if your home is valued at $100,000 and your current mortgage balance is $60,000, you could do a cash-out refinance for $80,000 and take $20,000 in equity out of your home. $60,000 in loan proceeds go to pay off your current mortgage balance and the remaining proceeds after closing costs and other expenses are deposited into your bank account. If closings costs are $2,000 in this example, then you would take out $18,000 in cash by refinancing ($80,000 (loan proceeds) - $60,000 (current loan balance) - $2,000 (closing costs) = $18,000 in borrower proceeds).

  • CalculatorUse our CASH-OUT REFINANCE CALCULATOR to determine how much equity you can take out when you refinance
  • To obtain a cash-out refinance you must have enough equity in your property to support a new higher mortgage amount. For a cash-out refinance, most lenders permit a maximum loan-to-value (LTV) ratio of 80%. LTV ratio is the ratio of your loan amount to the fair market value of your home. In the example above, the LTV ratio is 80% ($80,000 (new mortgage amount) / $100,000 (property value) = 80% LTV ratio). Your home must be worth enough to support your new mortgage amount while not exceeding the lender's LTV ratio limit.  If you do not have enough equity in your home either because your property value is less than expected, your mortgage balance is too high or you want to take out too much cash, you may exceed the lender's LTV ratio guideline and not be able to access the amount of proceeds you want with a cash-out refinance.

    Please note, if you are taking a significant amount of cash out -- greater than $250,000 -- lenders may apply a lower LTV ratio limit of 60% - 70%, depending on the loan amount and other factors including your credit score, debt-to-income ratio, income and assets. We recommend that you determine the estimated fair market value for your property before discussing a cash-out refinance with lenders so you understand what mortgage amount is achievable.

    The mortgage rate on a cash-out refinance is usually .250% to .750% higher than the rate on a standard refinance and potentially higher for larger, or jumbo, loans.  The table below compares refinance loan terms for leading lenders.  Because of the higher interest rate  and potential variation in pricing among lenders, we recommend that you contact multiple lenders and loan proposals.  Shopping lenders and comparing loan terms enables you to find the mortgage that is right for you.

  • %
    Current Refinance Mortgage Rates as of January 23, 2019
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    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click here for more information on rates and product details.
  • In a Cash-Out Refinancing What Can I Use the Proceeds for?
  • You can use the proceeds from a cash-out refinancing for numerous purposes including home remodeling, college tuition or to pay-off high cost debt.  Lenders typically request that you disclose what you intend to use the proceeds from the refinancing for.  If you disclose that you are going to use the proceeds to purchase a second home, investment property or to make a significant investment, the lender typically requests that you provide details about the property or investment.  Most borrowers disclose that they plan to use proceeds from a cash-out refinance for general home repairs and remodeling or simply put the money in the bank in which cases lenders typically do not request detailed follow-up information.

  • A Cash-Out Refinance Compared to a Separate Loan
  • If you are using the proceeds from a cash-out refinance for a major purchase such as college tuition, home remodeling or a new car it is important to compare the interest rate and term for your new mortgage with the rate and term for a loan if you financed the purchase separately. For example, if a construction loan charges a 10.0% interest rate then using a cash-out refinance mortgage with a 4.500% interest rate to pay for home renovations makes more financial sense.  On the other hand, if a student loan to pay for college tuition charges 3.0% then a cash-out refinance with a mortgage rate of 4.500% is not a good financing option because you would pay a higher interest rate on the new mortgage.

    It is also important to factor the length of any loan into your decision-making process. The longer the loan, the more total interest expense you pay. You may be able to save money on interest expense in the long run by obtaining a separate loan, such as a car, home improvement, home equity or student loan with a 10 to 20 year term, as compared to a cash-out refinance with a 30 year term.  In the short term, the monthly payment on a cash-out refinance may be lower than your current mortgage payment plus the payment for a separate loan, but the separate loan may actually save you money in the long term plus you can avoid the added expense of refinance closing costs.

  • Cash-Out Refinance Example
  • The example below shows how you can use a cash-out refinance to pay for a major purchase, such as college tuition in this case. In the example we show a borrower that owns a property with a value of $400,000 who needs $50,000 to pay for college.  The borrower originally took out a $300,000, 30 year fixed rate mortgage with a 5.000% mortgage rate to purchase the property.  The borrower is 10 years into the original mortgage and has a current principal loan balance of $244,000.  The borrower has $156,000 in equity in the property: $400,000 (property value) - $244,000 (current loan balance) = $156,000 in equity.

    The borrower refinances the original mortgage with a new 30 year fixed rate loan with an interest rate of 5.000%, so there is no change in rate.  The amount of the refinanced mortgage is $300,000, the same as the original loan.  By refinancing, the borrower is able to take out $54,500 in cash – the difference between the new mortgage and the principal balance of the original loan, less closing costs.  The enables the borrower to access sufficient finds to pay for college tuition while keeping the same mortgage rate and payment.  The borrower could also choose to include the closing costs in the new loan amount as long as the LTV ratio remains below lender's limit.  The example demonstrates how borrowers can use a cash-out refinance to access the equity in their property to cost-effectively finance a major purchase.

  • Original Mortgage

    Property Value $400,000
    Amount of Original Mortgage $300,000
    Years into Mortgage 10
    Current Principal Balance $244,000
    Equity in Property $156,000
    Interest Rate 5.0%
    Monthly Payment $1,610

    Refinance

    Mortgage Amount $300,000
    Pay-off Current Mortgage Balance ($244,000)
    Refinance Costs ($1,500)
    Cash-out Available to Borrower from Refinance $54,500

    Post-Refinance Mortgage

    Property Value $400,000
    Amount of New Mortgage $300,000
    Equity in Property $100,000
    Interest Rate 5.0%
    Monthly Payment $1,610
  • Use our personalized mortgage quote form to review no obligation loan quotes from top-rated lenders.  Our quote form is free, easy-to-use and does not impact your credit.  Comparing mortgage proposals enables you to find the best refinance terms including the lowest interest rate and closing costs.

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  • Sources

    Cash Out Refinance Guidelines: https://www.fanniemae.com/content/eligibility_information/eligibility-matrix.pdf

    Cash Out Refinance: http://www.freddiemac.com/singlefamily/factsheets/sell/cashoutrefi.htm

About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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