Cash-Out Refinance: How It Works and When It’s a Good Idea
A cash-out refinance allows you to convert your home equity into cash by borrowing more than you currently owe, paying off the old loan balance and pocketing the difference. You can use the money however you’d like, from paying off credit cards to remodeling an outdated kitchen.
Key takeaways about cash-out refinances
→ You’re borrowing more than you currently owe.
→ You need more than 20% home equity to qualify.
→ There are tougher requirements to meet than a traditional refinance.
→ You’ll likely have a larger monthly mortgage payment.
What is a cash-out refinance?
A cash-out refinance is when you replace your current mortgage with a larger loan and receive the difference in cash. Two important things to remember:
- The amount you can borrow is based on the amount of equity you have in your home
- You typically can’t borrow all of your home’s equity
Lenders calculate your home equity by subtracting your loan balance from your home’s appraised value. They also limit how much of your home’s value can be cashed-out by setting loan-to-value (LTV) ratio requirements. Most lenders set an LTV limit of 80%.
Because most cash-out refinance programs won’t let you borrow more than 80% of your home’s value, two more calculations are required to figure out how much of your equity can be converted to cash:
- First, multiply your home’s value by 80%: $450,000 x 0.80 is $360,000. This is your maximum loan amount.
- Then subtract the mortgage balance you owe on your current mortgage: $360,000 – $300,000 is $60,000. This is how much cash you’ll take home after paying off your mortgage.
→ The bottom line: You can’t borrow more than $60,000 of your $150,000 in home equity.
How to use a cash-out refinance calculator
If mortgage math makes your eyes glaze over, follow these three steps using LendingTree’s cash-out refinance calculator instead.
- Start with a home value estimator to get a rough idea of how much your home is worth.
- Check your most recent mortgage statement for your current mortgage balance.
- Enter the home equity amount you’d like to cash out.
The cash-out refinance calculator helps you determine whether you’re eligible to borrow the cash amount you entered. If you’re not, the calculator will recommend that you reduce your desired amount.
How does a cash-out refinance work?
For the most part, a cash-out refinance works like any other home loan. You shop for a mortgage lender, fill out a loan application and qualify based on your credit, income and assets. However, there are a few extra steps involved:
1. You must qualify for a higher loan amount
Because you’re taking out a new loan for more than you owe, your lender will need to verify your ability to afford a larger loan amount and higher monthly payment.
2. You’ll pay for a home appraisal
Until your home appraisal is completed, the cash-out refi loan amount is an estimate. Add to your home’s value before the appraisal by decluttering, adding a new coat of paint and cleaning up the landscaping. If your appraisal comes back lower than expected, however, you may not qualify to borrow as much home equity as you’d like.
3. Your lender finalizes your cash-out refinance loan amount
Once your appraisal comes back, the lender calculates your cash-out amount by:
- Subtracting your current loan balance from the final loan amount
- Subtracting refinance closing costs from your loan proceeds
4. Your old loan is paid off and you receive the cash-back difference
Once you review your closing disclosure to confirm the final figures and sign your closing papers, your lender funds your loan. Your old mortgage is paid off, the new mortgage is secured by your home and a wire or check is sent to you.
Cash-out refinance requirements
Cash-out refinance guidelines vary by loan type. Here’s a quick glance at some general guidelines for conventional, FHA and VA cash-out refi loans:
| Conventional | FHA | VA | |
|---|---|---|---|
| Maximum LTV ratio | 80% | 80% | 90% |
| Minimum credit score | 620 | 500 | No minimum |
| Maximum DTI ratio | 45% to 50% | 43% to 50% | 41% |
Maximum 80% LTV ratio
A maximum 80% LTV ratio is the standard for both FHA and conventional mortgages. However, eligible military homeowners can borrow up to 90% of their home’s value with a VA cash-out refinance.
Minimum 620 credit score
Conventional cash-out refinance guidelines require a 620 score. Meanwhile, the VA doesn’t set a minimum score standard, although many lenders also set theirs at 620. FHA loans are the exception: Borrowers may qualify with scores as low as 500.
Learn more about FHA cash-out refinances.
Maximum 43% DTI ratio
Lenders divide your total monthly debt by your pretax income to determine your debt-to-income DTI ratio, and prefer borrowers do not surpass a 43% DTI ratio. If you have a high DTI ratio, a high credit score and extra cash in the bank may help your approval odds.
Occupancy
You can only borrow a FHA or VA cash-out refinance loan for your primary residence. Conventional loans allow you to borrow against equity in a second home or investment property, if you’re willing to borrow less and pay higher rates.
Number of units
You’ll get the most cash out of a single-family home. Lenders apply lower LTV ratio limits to multifamily homes with two to four units.
Property type
Lenders may charge extra fees or higher rates to borrow equity from a condo or manufactured home. Some may even restrict the cash-out LTV ratio on these property types.
Waiting period
If you recently financed your home, you’ll need to wait 12 months before completing an FHA cash-out refinance. The 12-month waiting rule also applies to conventional cash-out refinances, with exceptions possible if:
- You received the property through an inheritance or legal agreement, like divorce or separation
- The property was purchased with all cash
The waiting period is only 210 days (about 7 months) if you qualify for a VA cash-out refinance.
Loan limits
Your cash-out refinance loan is subject to conventional and FHA loan limits, which are based on median home prices and change annually. Loan limits don’t apply to VA loans, though lenders may set their own maximums.
The 2023 single-family home limit for conventional loans is $726,200 and for FHA loans is $472,030.
How to get the best cash-out refinance rates
Cash-out refinance rates are generally higher than those offered on regular refinances. Turning equity into debt increases the odds you could lose your home to foreclosure, and lenders pass this risk on to you with higher rates.
However, there are some steps you can take to get the best rates.
Boost your credit score
Your credit score has a major impact on cash-out refinance rates. A 780 score or higher can get you the lowest rates on a conventional cash-out refinance. Although the minimum requirements are lower for FHA loans, your FHA interest rate is still tied to your credit score.
Pay off credit card balances months before you apply, avoid opening new credit accounts and pay everything on time. The extra effort could save you thousands of dollars in interest charges over a 30-year loan term.
Learn more about how to improve your credit score.
Borrow less
Your LTV ratio, how much you’re borrowing compared to the value of the home, is another factor that impacts your cash-out refinance rate. The higher your LTV ratio, the higher your rate will be.
One way you can borrow less money and lower your LTV ratio by increasing your down payment amount. There are many options for making a larger down payment, including applying for down payment assistance or getting a gift letter from a family member.
Learn more about borrowing money for a down payment.
Read more about finding how much you should put down on a house.
Make home improvements
The right home improvements could increase your home’s value, lower your LTV ratio and lead to a lower cash-out refinance rate. Check Remodeling Magazine’s most recent Cost vs. Value Report to learn which improvements give you the most value-improvement bang for the buck.
Shop around for lender offers
LendingTree studies consistently show that mortgage shoppers save serious money versus those that don’t shop. Collect loan estimates from three to five lenders or use an online comparison site and let lenders compete for your business.
Read more about our best refinance lenders.
Cash-out refinance closing costs: How much you’ll pay
Refinance closing costs typically range from 2% to 6% of your loan amount, depending on your loan size. You’ll pay the same types of fees for a cash-out refinance as a purchase mortgage, which include origination, title, appraisal and credit report costs.
Keep in mind: Origination fees and premiums for title and homeowners insurance are based on a percentage of your loan amount. As such, the more you borrow, the more you’ll spend on these closing costs.
How are cash-out refinance costs paid?
You may be familiar with mortgage insurance if you made less than a 20% down payment when you bought your home. The good news is you won’t pay for private mortgage insurance on a conventional cash-out refinance, since the maximum 80% LTV ratio is the cutoff point to skip that requirement.The bad news is that you’ll pay FHA mortgage insurance on an FHA cash-out refinance regardless of your LTV ratio. And although VA loans don’t require mortgage insurance, military homeowners usually pay a VA funding fee of 2.30% to 3.60% of their loan amount for a VA cash-out refinance.
Is a cash-out refinance a good idea?
A cash-out refinance could be a good idea for someone who would like extra funds to use for any purpose, meets the qualifications and can afford a higher monthly mortgage payment, and hopes for lower interest rates than other loan options. But before you decide if a cash-out refinance is the right option, you should review the benefits and drawbacks.
Pros
You can use the cash you take out for any purpose. Consolidate debt, invest in real estate or set aside the cash for something else — your home equity can be used as you see fit.
You’ll get a lower interest rate compared to other financing options. Mortgages typically have lower interest rates than credit cards, personal loans and home equity loans, which clears out room in your monthly budget.
Your interest charges may be tax-deductible. If you use your funds for home improvements, you can deduct the interest you paid over the year when you file your taxes.
Cons
You’ll need 20% equity to qualify. If home values have tumbled in your area or you bought your home with a small down payment, a cash-out refinance may not be possible right now.
You’ll lose some of the equity you’ve built. Borrowing against your home equity now means a smaller profit when you sell your home later.
You’ll have a higher monthly mortgage payment. In most cases, a higher loan amount will mean a higher monthly mortgage payment for as long as you own your home.
You may pay a higher rate than you would with a different type of refinance. Lenders typically charge higher rates for cash-out refinances than rate-and-term refinances. Low-credit-score borrowers can expect an even higher rate if they’re tapping equity.
Cash-out refinance vs. HELOC
A home equity line of credit (HELOC) is like a credit card. You can borrow against it and pay it off as needed during your “draw period,” which usually lasts 10 years. You only pay on the borrowed funds, and many HELOC lenders offer an interest-only payment option during the draw period. Once the draw period ends, the repayment period starts, and usually lasts 20 years. During this time, you’ll pay off the balance with regular payments.
One advantage of HELOCs: Most HELOC lenders allow you to borrow up to 85% of your home’s value. Some HELOC lenders will even lend up to 100% — much more than the 80% cap on most cash-out refinances.
Think a home equity loan or HELOC is right for you? Try our home equity calculator to see how much money you could get.
Which loan makes sense for me?
→ A HELOC makes sense if: You have a relatively high credit score, don’t need access to the full amount of funds all at once or want an interest-only payment period. It’s also a good choice if you want to tap equity without touching a low-interest-rate first mortgage.
→ A cash-out refinance makes sense if: You want the lowest possible monthly payment, have low credit scores or prefer a stable monthly payment that won’t fluctuate.
Cash-out refinance vs. home equity loan
Another equity-tapping option is a home equity loan, which is a loan against a portion of the equity in your home. You’ll receive all the funds at once and repay the loan on a fixed installment schedule. Terms often range from five to 30 years.
Like HELOCs, home equity lenders may set LTV ratios up to 100%, though most keep the maximum at 85%.
Which loan makes sense for me?
→ A home equity loan makes more sense if:
- You need to borrow more equity than cash-out refinance programs allow
- You want to leave your current, low-interest-rate mortgage alone
- You don’t mind making two monthly mortgage payments
- You have a higher credit score
→ A cash-out refinance makes more sense if: Your credit scores are too low to qualify for a home equity loan, or you only want one monthly payment.
Frequently asked questions
Yes, if you qualify. However, you’ll be limited to a lower LTV ratio and should expect a higher interest rate. Lenders limit the LTV ratio for cash-out refis on investment properties to 75%, meaning you’ll need at least 25% equity after closing.
Yes, you may qualify to take out equity on a second home, but you’ll be subject to the same rates and LTV limits as investment property cash-out refinances.
The amount of cash you can borrow depends on your chosen loan program’s maximum LTV ratio. For example, you can borrow up to 80% of your home’s value with a conventional cash-out refi.
Yes, if you use the funds exclusively for home improvements. The tax break doesn’t apply if you use cash-out refinance funds for any other purpose.