Cash-out refinance: Is it worth it?

What is a cash-out refinance?

If you want to tap into your home equity, a cash-out refinance is worth considering.

Cash-out refinancing lets you take out a new mortgage for more than you owe on your existing one — and keep the difference in cash. The amount you may qualify for depends in part on how much equity you have in your home.

You might use the money to invest in home improvements, consolidate high-interest debts or pay for other pressing needs. But a cash-out refi isn’t always your best option.

We’ll walk through how a cash-out refinance works, when it might make sense to consider and what alternatives you should weigh.

• How does a cash-out refinance work?
• Cash-out refinance requirements
• Does a cash-out refinance affect taxes?
• Is a cash-out refinance a good idea?
• Which is better: a cash-out refinance or home equity loan?
• How to prepare and apply for a cash-out refinance
• Cash-out refinance mortgage lenders
• FAQs about cash-out refinance

How does a cash-out refinance work?

A traditional mortgage refinance and cash-out refi both involve taking out a new loan to pay off your existing mortgage. With a traditional refinance, you borrow about the same amount as you currently owe and try to get a lower interest rate, different term or both.

Your interest rate and term could also change with a cash-out refi, but the idea is to borrow more than you currently owe and use the extra cash for something else.

If you’re just looking to lower your interest rate, a traditional refi may be the better option because it tends to have lower rates than a cash-out refi.

Cash-out refinance requirements

To qualify for a cash-out refinance, you typically need to have a certain percentage of equity in your home, just as you would if you were getting a home equity loan or HELOC. The amount of equity you need varies based on the type of mortgage you have.

To calculate the amount of equity you’ve built up, lenders need an accurate assessment of your property’s value. Some require an appraisal to determine how much your home’s worth.

How much money can you take out with a cash-out refinance?

You usually can’t refinance the entire value of your home. You typically need to have some equity to qualify for a cash-out refinance — but there are exceptions.

With a conventional loan or FHA loan, the maximum loan-to-value ratio, or LTV, lenders allow is typically 80%. For example, if your home is worth $400,000, the most you could borrow would be $320,000. If you owe $250,000 on your existing mortgage, you could pocket up to $70,000 after paying off your current loan with the new one ($320,000 – $250,000 = $70,000).

Keep in mind that if you have an FHA loan, you can’t borrow more than the FHA’s loan limits no matter what your LTV is. If you have a VA loan, you may be able to borrow up to 100% of the property’s market value.

Does a cash-out refinance affect taxes?

No, a cash-out refinance is not considered taxable. You don’t have to pay taxes on the cash you receive from a cash-out refinance because it isn’t income. It’s a loan you must repay.

But if you use the money to make home improvements, you may be able to deduct the interest from your income taxes.

The interest you pay on the first $750,000 of mortgage debt — or $375,000 if you’re married, filing separately — is deductible, according to the IRS. You can’t deduct the interest if you use the extra cash for expenses not related to home improvement.

Is a cash-out refinance a good idea?

After paying off the original mortgage and associated fees, there aren’t usually any restrictions around how you use the money you receive on a cash-out refinance. But consider carefully how you choose to spend it.

“People might regret using the money to splurge on a luxury,” says Rebekah Tardieu, a mortgage loan originator with Cardinal Financial Company in Melville, New York. She suggests “trying to use the money to put yourself in a better financial position.”

Pros of a cash-out refinance

If you’ve accumulated equity in your home, it makes sense that you want to tap into it to achieve another financial goal. Here are some situations when you might want to consider a cash-out refinance.

• Consolidate higher-interest debts — A potential good use of a cash-out refi is to consolidate high-interest debt, such as credit card debt and personal loans. There’s also a potential tax benefit as mortgage interest may be tax-deductible, while interest on personal loans, credit cards and auto loans often isn’t. But be sure to look at the total financing costs, not just the interest rate. Between closing costs and the potentially longer term, a cash-out refi might not always make financial sense.
• Pay for higher education — If you have a college-aged child, using a cash-out refi could be a good alternative to taking out private student loans, which might have a higher interest rate.
• Make home improvements or repairs — Using the money to remodel or expand part of your home, or for critical maintenance, could pay for itself by raising the home’s value. But don’t rely on a cash-out refi for a quick fix during a home emergency — the renovation process could take months to complete.

Cons of a cash-out refinance

While there may be many reasons you want a cash-out refi, it might not always make sense. Here’s why.

• You could wind up with a higher interest rate. Refinancing changes your mortgage’s terms, which could include your interest rate, and you could wind up with a higher mortgage rate. Ask yourself if losing the low rate is worth the access to cash.
• You’ll need to pay closing costs. As with other types of mortgage refinances, cash-out refis require you to pay closing costs. The costs can vary depending on your new loan’s balance, and they could add up to hundreds or thousands of dollars. So it may not make sense to spend $2,000 on closing costs to cash out $5,000.
• Your monthly payment may be higher. Depending on the term you choose and the rate you qualify for, your monthly payment could be higher because you’re taking out a new mortgage for a larger amount than your existing one. Make sure that your new payments comfortably fit in your budget so that you don’t risk missing mortgage payments.

Which is better: a cash-out refinance or home equity loan?

If refinancing won’t lower your interest rate, you may want to consider a home equity line of credit (HELOC) or home equity loan (HEL) instead. These are sometimes called second mortgages, but they won’t replace your mortgage or change your mortgage terms.

A home equity loan gives you a lump-sum payout and uses your home as collateral. A HELOC also uses your home as collateral, but you can borrow money as needed until you’ve maxed out the line of credit or the draw period ends (often 10 years later).

While the interest rate on a home equity loan or HELOC might be higher than what you’d pay on a cash-out refi, you won’t lose your current mortgage rate, and you might not have to pay as much in closing costs. You should crunch the numbers to figure out which option is best for you.

How to prepare and apply for a cash-out refinance

Applying for a cash-out refinance is similar to applying for a first mortgage. Here are a few steps to help you get ready.

• Check your credit. You’re getting a new loan, so your lender will pull your credit. Make sure yours is in shape and resolve any errors before applying. Higher credit scores generally qualify for lower rates and better loan terms. You can check your VantageScore 3.0 credit scores for free on Credit Karma.
• Reduce debt. When applying for a mortgage, you typically need a debt-to-income (DTI) ratio of 36% to 45% — or less. If yours is higher than that, consider paying down some of your debt before applying. It may improve your chances of qualifying.
• Collect the necessary documents. Your lender needs a variety of home loan documents to process your application, including your tax returns, proof of income, bank and investment statements and photo ID.
• Get multiple quotes. Since rates and terms vary from lender to lender, it’s a good idea to get multiple mortgage rate quotes before choosing a home loan to ensure you get the loan that best meets your needs.

Cash-out refinance mortgage lenders

If refinancing looks like the right path for you, here are some lenders that offer cash-out refinances that we think are worth exploring.

• Better mortgage — Better mortgage offers cash-out refinances with maximum LTVs of 75% to 80%, depending on the property type. The company’s application is 100% online, and there are no origination, application, processing or underwriting fees. But you will have to pay closing costs and third-party settlement fees.
• CrossCountry Mortgage — CrossCountry Mortgage has a variety of refinance loan types, including cash-out, conventional VA, USDA and HARP. Your loan may close in as little as 21 days.
• Discover mortgage — Discover offers refinancing for home loan amounts ranging from $35,000 to $300,000. The company has no application, origination or appraisal fees, and no cash is due at closing. But if you pay off your loan within 36 months of closing, you must reimburse the company for closing costs of up to $500.
• Freedom Mortgage — Freedom Mortgage offers cash-out refinancing on conventional, FHA and VA loans. You can see your estimated rate and loan term with no impact to your credit scores before submitting a formal application. 
• GO Mortgage — GO Mortgage offers cash-out refinances for applicants with minimum credit scores of 620. You can choose from fixed and adjustable interest rates, but home loans from this company aren’t available in all states. 
• Pennymac — Pennymac offers multiple cash-out refinancing options, including conventional, FHA, VA and jumbo loans. Most borrowers need at least 20% equity in their home to qualify for a cash-out refinance, but VA loan recipients may be able to borrow up to 90% of their home’s value.  

Next steps

If you think a cash-out refinance is a good possibility for you, make sure to compare mortgage lenders. If you’re shopping for a mortgage, you have a window of time where multiple credit inquiries are only counted as one for your credit scores. You typically have 14 days — though it could be longer depending on the scoring model.

Here are some questions to ask yourself.

• What closing costs does the lender charge?
• Will you need an in-person appraisal?
• What percent of your equity will the lender qualify you to access?
• What will your new interest rate be?
• What’s your “break-even” point after closing costs?
• Has your credit improved since you took out your original mortgage?
• Does a home equity loan or HELOC make more sense for your financial goals?

FAQs about cash-out refinance