Cash-Out Refinance: How It Works and What to Know - NerdWallet (2024)

With a cash-out refinance, you get a new home loan for more than you currently owe on your house. The difference between that new mortgage amount and the balance on your previous mortgage goes to you at closing in cash, which you can spend on home improvements, debt consolidation or other financial needs.

However, you'll now be repaying a larger loan with different terms, including a new mortgage rate, so it's important to weigh the pros and cons before committing to a cash-out refi.

What is a cash-out refinance?

With a standard rate-and-term refinance, you get a new interest rate or mortgage term without changing the balance of the loan. You might do this because rates have gone down, for example, and you want a lower monthly payment or because you need to add or remove a borrower.

In contrast, a cash-out refinance gives you a new loan that's larger than your current mortgage balance — and you pocket the difference.

How much cash you’re eligible to access depends upon your home equity — how much your home is worth compared to how much you owe.

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

Steps to getting a cash-out refinance

  • Determine your home equity. Home equity is the market value of your home minus what you still owe. For example, if your home is worth $300,000 and you have $100,000 remaining on your loan, you have $200,000 in home equity.

  • Calculate the maximum loan you can take out. In general, that’s 80% of your home’s value. Using the previous example, you would multiply $300,000 times 0.80 for a maximum of $240,000. Remember that this isn’t the same as 80% of the purchase price; your home’s value may be different now than it was when you bought it.

  • Subtract your current mortgage balance. From that new $240,000 loan, you’ll have to pay off what you still owe on your home: $240,000 - $100,000 = $140,000.

  • Estimate your total. In a cash-out refinance, you receive the difference between the balance on your previous mortgage and your new, larger mortgage. In this example, it's as much as $140,000.

  • Shop rates from multiple lenders. This will help you to get the best deal.

  • Weigh alternatives. Once you’ve researched available rates, calculate your new monthly mortgage payment and determine if it makes sense and is affordable for you. If not, you may be better off pursuing another type of loan.

  • Submit an application. As with your original mortgage, you’ll have to go through the appraisal and underwriting process before closing on the loan and accessing your cash.

🤓Nerdy Tip

Just like with your first mortgage, you’ll have to pay closing costs and fees on a cash-out refinance. These can total 2%-6% of the loan amount. In our example, closing costs for a $240,000 loan could range from $4,800 to $14,400.

» MORE: See the best cash-out refinance lenders

Cash-out refinance requirements

In order to get a cash-out refi, you'll have to meet lender requirements. These can vary across lenders, so it's smart to shop around for the best interest rate.

But you'll likely need to meet these qualifications:

Debt-to-income ratio

Your DTI is your monthly debt payments, including your current mortgage, divided by your gross monthly income. For a cash-out refi, you'll usually need a DTI of 45% or less. If your DTI is over 45%, you may be required to have six months of reserves in the bank.

Credit score

You may qualify for a cash-out refinance with a score of 620, but a higher credit score will help you get a better interest rate.

Home equity

You'll usually need at least 20% equity in your home to qualify for a cash-out refinance. In other words, you'll need to have paid off at least 20% of the current appraised value of the house.

Seasoning requirement

With a conventional loan, you'll need to have owned the house for at least six months to qualify for a cash-out refinance, regardless of how much equity you have. Lenders might make an exception if you inherited the property or it was otherwise legally awarded to you.

VA loan borrowers must wait at least 210 days, while borrowers who have a loan backed by the Federal Housing Administration need to have lived in the home for at least 12 months before doing an FHA cash-out refinance.

Mortgage loans from our partners

Check Rate

on New American Funding

New American Funding

4.5

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (2)

4.5

NerdWallet rating

Min. credit score

500

Min. down payment

3.5%

Check Rate

on New American Funding

Check Rate

on Rocket Mortgage

Rocket Mortgage

5.0

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (6)

5.0

NerdWallet rating

Min. credit score

580

Min. down payment

3.5%

Check Rate

on Rocket Mortgage

Check Rate

on Veterans United

Veterans United

4.5

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (8)

4.5

NerdWallet rating

Min. credit score

620

Min. down payment

0%

Check Rate

on Veterans United

Check Rate

on Better

Better

4.5

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (10)

4.5

NerdWallet rating

Min. credit score

620

Min. down payment

3%

Check Rate

on Better

COMPARE MORE LENDERS

Mortgage loans from our partners

Check Rate

on New American Funding

New American Funding

4.5

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (12)

4.5

NerdWallet rating

Min. credit score

500

Min. down payment

3.5%

Check Rate

on New American Funding

Check Rate

on NBKC

NBKC

4.5

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (14)

4.5

NerdWallet rating

Min. credit score

620

Min. down payment

3%

Check Rate

on NBKC

Check Rate

on Rocket Mortgage

Rocket Mortgage

5.0

NerdWallet rating

Cash-Out Refinance: How It Works and What to Know - NerdWallet (16)

5.0

NerdWallet rating

Min. credit score

580

Min. down payment

3.5%

Check Rate

on Rocket Mortgage

COMPARE MORE LENDERS

Pros and cons of a cash-out refinance

A cash-out refinance can be a wise move or a risky one, depending on your financial situation and how you plan to spend the money.

In a cash-out refinance, you can access a large amount of cash at a relatively low interest rate (compared to personal loans or credit cards, for example). However, since you’re using your home as the collateral, you risk losing your home if you can’t make the payments.

Before you sign, think through these pros and cons.

Pros:

  • Potentially lower interest rate. Though cash-out refinance rates tend to be higher than rate-and-term refinance rates, you might still end up with a lower interest rate if mortgage rates were higher when you originally bought your home. However, if you only want to lock in a lower interest rate on your mortgage and don’t need the cash, a rate-and-term refinance makes more sense.

  • Just one loan. Since it's a refinance, you'll deal with one loan payment per month. Other ways of leveraging home equity require a second mortgage.

  • Access to more funds. Cash-out refinances are helpful with major expenses, like a home renovation or college tuition, because you generally can borrow much more than you could with a personal loan or by using credit cards.

  • Helpful for debt consolidation. Using the money from a cash-out refinance to pay off high-interest credit cards could save you thousands of dollars in interest.

  • May build credit. Paying off your credit cards in full with a cash-out refinance may build your credit score by reducing your credit utilization ratio — the amount of available credit you’re using.

Cons:

  • Foreclosure risk. Because your home is the collateral for any kind of mortgage, you risk losing it if you can’t make the payments. For this reason, experts usually advise against using one to pay off unsecured debt, like credit card balances.

  • New terms. Your new mortgage will have different terms from your original loan, so review them carefully to understand what changed. Also, take a look at the total interest you'd pay over the life of the loan. Assuming you're refinancing into a new 30-year mortgage, that could add years of repayment, possibly piling on a substantial amount of interest — even if you've lowered your rate.

  • Time-consuming. You're getting a new mortgage, and while you won't jump through all the hoops of a purchase loan, underwriting can still take weeks. If you need funds urgently — maybe your leaky roof is causing serious water damage and needs replacing ASAP — refinancing may not be your best bet.

  • Closing costs. You’ll pay closing costs for a cash-out refinance, as you would with any refinance. Refinance closing costs are typically 2% to 6% of the loan. That’s $4,800 to $14,400 for a $240,000 refi. This can take a big bite out of the cash you'll receive at closing.

» MORE: When's the right time to refinance?

Alternatives to cash-out refinance

There are ways to tap into your home equity without doing a cash-out refinance. Home equity loans and home equity lines of credit (HELOCs) also allow you to borrow against your home equity. They're both types of second mortgages, which means you take them out in addition to your current mortgage.

Home equity loan

With a home equity loan, you borrow a lump sum — not too different from what you'd get with a cash-out refinance. However, since you aren't touching your primary mortgage, its interest rate won't change. With a home equity loan, you can typically borrow around 80% or more of your home’s value, minus what you still owe.

Home equity line of credit

A HELOC is more flexible, giving you a line of credit that you draw from as needed. Most HELOC lenders let you borrow up to 80% of your home’s value, minus what you still owe, though some lenders set higher or lower limits.

Both home equity loans and HELOCs have minimal closing costs, but because they are second mortgages, their rates are generally higher than you'd get with a cash-out refinance.

» MORE: Cash-out refinance vs. home equity loan or HELOC

Is a cash-out refinance a good idea?

A cash-out refinance can make sense if you're able to get a good interest rate on the new loan. The answer also depends on what you plan to do with the money. Seeking a refinance to fund vacations or a new car isn't a good idea because you'll have little to no return on your money. On the other hand, using the money to fund a home renovation can rebuild the equity you're taking out.

Either way, you’re using your home as collateral for a cash-out refinance, so it's important to make payments on your new loan on time and in full.

Frequently asked questions

How does a cash-out refinance work?

With a cash-out refinance, you take out a new mortgage that's for more than you owe on your existing home loan, but less than your home's current value. At closing, you'll receive the difference between the new amount borrowed and the loan balance.

How do you get the best cash-out refinance rate?

Shop around with multiple lenders to compare cash-out refinance rates. You may also be able to buy points to bring down your refinance interest rate. While you're comparing lenders, be sure to also check the costs and fees associated with getting the refinance. These don't affect your rate, but fewer added fees will lower your closing costs.

How long do you have to wait to get a cash-out refinance?

With a conventional loan, you'll need to have owned the house for at least six months to qualify for a cash-out refinance. You can't do a cash-out refinance on a VA loan until you've met a 210-day seasoning requirement or made six monthly payments, whichever is longer. With an FHA loan, you aren't eligible for a cash-out refinance for 12 months. With all of these, there are exceptions for circ*mstances like divorce or inheritance.

Do you pay taxes on a cash-out refinance?

No. Since this cash is considered a loan, it’s not subject to income tax. However, depending on how you spend the cash, you might be able to write off the interest you pay.

Generally, you can deduct the interest up to IRS limits if you spend the money on permanent projects that add value to your home. Check with a tax professional, but those can include adding a bedroom, replacing your roof or installing a swimming pool. Routine repairs or painting typically don’t count because they don’t increase your home’s value.

If you use the cash for reasons outside of home improvement, such as tuition payments or debt consolidation, you can’t deduct the interest.

Cash-Out Refinance: How It Works and What to Know - NerdWallet (2024)

FAQs

Cash-Out Refinance: How It Works and What to Know - NerdWallet? ›

With a cash-out refinance, you get a new home loan for more than you currently owe on your house. The difference between that new mortgage amount and the balance on your previous mortgage goes to you at closing in cash, which you can spend on home improvements, debt consolidation or other financial needs.

What is the downside of a cash-out refinance? ›

Cash-out refinance cons

You owe more: Because you're taking out a larger loan amount, your overall debt load increases. No matter how close you were to paying off your original mortgage, the cash out raises your debt level.

How does cash-out refinancing work? ›

In a cash-out refinance, a new mortgage is taken out for more than your previous mortgage balance, and the difference is paid to you in cash. You usually pay a higher interest rate or more points on a cash-out refinance mortgage compared to a rate-and-term refinance, in which a mortgage amount stays the same.

Is it hard to get approved for a cash-out refinance? ›

Determining whether you qualify: Many cash-out refinance lenders require a credit score of at least 620 and at least 20 percent equity in your home. You might find lenders with looser requirements, but you could pay a higher rate as a result.

What is the formula for cash-out refinance? ›

Keeping the maximum 80% LTV ratio requirement in mind, you may borrow up to an additional $60,000 with a cash-out refinance. To calculate this, multiply your home's value by 80% ($450,000 x 0.80 = $360,000) and subtract your outstanding loan balance from that amount ($360,000 – $100,000 = $60,000).

Do you lose your interest rate with a cash-out refinance? ›

Will my rate increase if I take cash-out? It's possible. If prevailing market rates are close to or higher than rates when you bought your home, your cash-out refinance rate will be higher than your current rate. Compared to a rate-and-term refinance with no cash-out, cash-out rates also trend higher.

Does cash-out refinancing hurt your credit? ›

For cash-out refinances: Raising your credit utilization

A higher utilization could make your credit scores drop. If you're using the cash from your cash-out refinance to pay down high-interest debt, though, refinancing could ultimately have a positive effect on your score.

Do you pay taxes on cash-out refinance? ›

Is the cash from a cash out refinance taxable? No, the cash you receive from a cash out refinance isn't taxed. That's because the IRS considers the money a loan you must pay back rather than income.

How long does it take to get your money from a cash-out refinance? ›

Expect a cash-out refinance to take 45 to 60 days, but with a little help, you may speed up the processing time. The faster you provide documentation and secure the appraisal, the faster your lender can underwrite and process your loan. It's a team effort to get the cash in hand that you want from your home equity.

What is the current interest rate on a cash-out refinance? ›

Refinance rates by loan term
ProductPayment*Interest rate
30-year fixed rate$1,600.786.625 %
20-year fixed rate$1,809.156.125 %
15-year fixed rate$2,126.566.125 %
10-year fixed rate$2,759.855.875 %

Can you get denied for a cash-out refinance? ›

For example, you typically must have at least 20% in equity in your home to get a cash-out refinance and if you don't your refinance could be denied. A no cash-out refinance can be denied if you do not have a good credit history or enough income to meet the lender's criteria.

Can I do a cash-out refinance with bad credit? ›

If you want to do a cash-out refinance, know that you'll need a credit score of at least 580 for an FHA cash-out refinance or 620 for most other cash-out refinances. Otherwise, explore your options and see if refinancing right now is the best financial choice for you.

What is the minimum credit score for a cash-out refinance? ›

Cash-out refinance

On a cash-out conventional refinance, you'll need a 640 credit score at minimum. To qualify with a 640, you will need a loan-to-value ratio of 75% or less, at least six months in cash reserves, and a debt-to-income ratio of 36% or lower.

Is it smart to do a cash-out refinance? ›

A cash-out refinance can be a good idea if you have a good reason to tap the value in your home, like paying for college or home renovations. A cash-out refinance works best when you are also able to score a lower interest rate on your new mortgage, compared with your current one.

What is a cash-out refinance for dummies? ›

With a cash-out refinance, you get a new home loan for more than you currently owe on your house. The difference between that new mortgage amount and the balance on your previous mortgage goes to you at closing in cash, which you can spend on home improvements, debt consolidation or other financial needs.

What is the maximum amount for a cash out refi? ›

Generally, the amount you can borrow with a cash-out refinance is capped at 80% of your home value. However, this can vary depending on the lender and loan type you choose. For example, you can borrow 100% of your home's equity through a VA cash-out refinance.

Does your payment go up with a cash-out refinance? ›

For most homeowners, your monthly mortgage payment will increase with a cash-out refinance because you're borrowing more than you currently owe on your mortgage.

Does a cash-out refinance require closing costs? ›

A cash-out refinance comes with closing costs comparable to your first mortgage. Typically, you can expect to pay between 2% and 5% of the loan amount. So on a $200,000 home loan refinance, you could pay between $4,000 and $10,000 in closing costs.

Do you lose equity when you refinance? ›

The bottom line. You don't have to lose any equity when you refinance, but there's a chance that it could happen. For example, if you take cash out of your home when you refinance your mortgage or use your equity to pay closing costs, your total home equity will decline by the amount of money you borrow.

Is it better to sell or cash-out refinance? ›

If you like your home and neighborhood and you expect to stay for at least five years, refinancing is the better choice. However, if you're ready for a new environment (or this is a good time to downsize), selling may afford you more opportunities.

Top Articles
Latest Posts
Article information

Author: Margart Wisoky

Last Updated:

Views: 6197

Rating: 4.8 / 5 (58 voted)

Reviews: 81% of readers found this page helpful

Author information

Name: Margart Wisoky

Birthday: 1993-05-13

Address: 2113 Abernathy Knoll, New Tamerafurt, CT 66893-2169

Phone: +25815234346805

Job: Central Developer

Hobby: Machining, Pottery, Rafting, Cosplaying, Jogging, Taekwondo, Scouting

Introduction: My name is Margart Wisoky, I am a gorgeous, shiny, successful, beautiful, adventurous, excited, pleasant person who loves writing and wants to share my knowledge and understanding with you.