Cash-out refinance: Is it worth it?

Written by: Louis DeNicola
• Updated •8 min read • Leer en español
This date may not reflect recent changes in individual terms.
Young couple in their living room, learning about a cash out refinance on their laptop.Image: Young couple in their living room, learning about a cash out refinance on their laptop.

In a Nutshell

A cash-out refinance lets you tap into the equity you’ve built up in your home by paying off your existing mortgage and replacing it with a larger mortgage amount — and accessing the difference as a cash payment. But you’ll want to consider the costs and the effect it’ll have on your mortgage’s rate, term and payments.
Louis DeNicola is a personal finance writer and has written for American Express and Discover. Editorial Note: Intuit Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our third-party advertisers don’t review, approve or endorse our editorial content. Information about financial products not offered on Credit Karma is collected independently. Our content is accurate to the best of our knowledge when posted.

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?

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.

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.

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.

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.

If you use the cash for debt consolidation, for example, the IRS won’t let you deduct interest on your cash-out refinance. But you might qualify for a deduction if you put your proceeds toward the following:

Making capital home improvements

One way to lower your tax bill through a cash-out refinance is to use the cash for capital home improvements that increase your home’s value, improve its longevity or change it so that it adapts to new needs.

These may include permanent updates such as …

  • Adding a bath or bedroom
  • Installing energy-efficient doors or windows
  • Updating the roof
  • Upgrading the HVAC system

Setting up a home office

If you’re self-employed or a small business owner and add a home office, you might be able to deduct the interest you pay toward your cash-out refinance. To do so, you must use your home office for business purposes only and show that it’s the main place where you conduct your business.

To calculate your deduction, you’ll need to choose from one of these two methods.

  • Simplified method — Deduct $5 for each square foot of your home office. With this method, you can deduct up to 300 square feet or $1,500.
  • Standard method — If your home office is more than 300 square feet, the standard method is for you. It gives you a deduction based on the size of your office in relation to certain costs of your home.

Buying mortgage points

Another way to lower your interest payments on a cash-out refinance is to buy mortgage points to reduce your mortgage rate. Keep in mind that if you go this route, you won’t be able to claim all your points the year you refinance.

Let’s say you take out a cash-out refinance for 15 years and buy $2,000 in mortgage points. In this case, you could deduct $133 from your taxes each year you have the loan.

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 and the company’s application is 100% online. 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 and USDA. Your loan may close in as little as 21 days.
  • Discover mortgage — Discover offers refinancing for home loan amounts ranging from $35,000 to $500,000. The company has no application, origination or appraisal fees, and no cash is due at closing.
  • Freedom Mortgage — Freedom Mortgage offers cash-out refinancing on conventional, FHA and VA loans.
  • 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 more 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?

Mortgage rates where you live

Mortgage or refinance rates depend on different factors, including where you live. To better understand what rates you may qualify for, including what the average mortgage or refinance rate is in your area, take a look at Credit Karma’s marketplaces for mortgage rates and mortgage refinance rates.

FAQs about cash-out refinance

What is a cash-out refinance?

With a cash-out refinance mortgage, you can use the equity in your home to get cash back to use for your financial goals by taking out a new mortgage worth more than you owe. You pay off your current mortgage with the new loan and keep the extra cash to pay for other expenses.

When is cash-out refinance a good option?

A cash-out refinance could be a good option when you need extra cash to cover a large expense such as a home improvement project — if you can get a loan with the same or a lower rate than your current mortgage.

How much can I get with a cash-out refinance?

It depends on the type of loan you have. Most lenders cap the amount you can borrow at 80% of your home's value but you may be able to get up to 100% with certain types of loans. You generally need to have at least 20% equity in your home to get a cash-out refinance.

What is the downside of a cash-out refinance?

With a cash-out refinance, you'll owe more. If you're unable to make your payments, you could lose your home.

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

A cash out refinance is an installment loan that you repay in equal amounts over a fixed period of time. A HELOC is a line of credit you can borrow against and repay (with interest) repeatedly as long as you don't exceed the line's credit limit.

About the author: Louis DeNicola is a personal finance writer and has written for American Express, Discover and Nova Credit. In addition to being a contributing writer at Credit Karma, you can find his work on Business Insider, Cheapi… Read more.