Cash-Out Mortgage Refinance Pros and Cons
Editorial Note: Articles published are intended to provide general information and educational content related to personal finance, banking, and credit union services. While we strive to ensure the accuracy and reliability of the information presented, it should not be considered as financial advice and may be revised as needed.
The term cash-out refinance refers to obtaining a new mortgage to replace your existing one and getting cash back in the process. You take out a new loan for a greater amount than your current mortgage and spend the money how you see fit.
Conventional and Federal Housing Administration (FHA) loans allow homeowners to access up to 80 percent of their home’s value. You could receive up to 100 percent of your home’s value with a Veterans’ Administration (VA) loan.
Read on to learn more about the pros and cons of a cash-out mortgage.
Table of Contents
You can access the information you need faster by clicking on any link below. Each section covers a different aspect of cash-out refinancing.
Typical Qualifications for a Cash-Out Mortgage Refinance
Remember that each lender will have slightly different qualification requirements for this type of refinance deal. However, here are the most common criteria:
A minimum credit score of 620
After taking out the loan, you must maintain at least 20 percent equity in your home. Lenders refer to this as an 80 percent or greater loan-to-value ratio.
50 percent or lower debt-to-income ratio
Here are the factors lenders consider when determining how much loan to offer you:
The current value of your home
How much you owe on your current mortgage
Amount of equity required by the lender
The amount of cash you will receive is the difference between the new loan amount and the balance on your existing mortgage.
You will also need to present several forms of documentation as part of the application process. Typical examples include proof of income, satisfactory payment history on your current mortgage, and a current appraisal of your home conducted within the last 90 days.
Pros and Cons of a Cash-Out Refinance
As with most things, there are pros and cons of a cash-out refinance that you should consider before making a decision.
Cash-Out Refinance Pros
One of the leading reasons people apply for a cash-out refinance is to lower their mortgage interest rate. With mortgage rates trending downward, you may significantly reduce your monthly payment. You’ll also pay a lower interest rate on the cash you access than credit cards or conventional loans.
Here are some other benefits to consider:
Access to a large sum: Unlock your home’s equity to get the funds you need for major expenses.
Debt consolidation: Combine credit card and installment debt into one payment with a lower interest rate. Keep in mind that while you’ll save on interest upfront, extending the repayment term could cost more over time.
Predictable payments: Refinancing to a fixed-rate loan keeps your monthly principal and interest payments consistent. This differs from variable-rate options such as HELOCs.
Tax deductions: You may deduct the interest paid on the cash you take out if used for eligible home improvements.
Credit score boost: Consolidating high-interest debt with a cash-out refinance could improve your credit score.
Return on investment: Use the funds for home repairs or college tuition expenses. These investments can add long-term value to your life or property.
Cash-Out Refinance Cons
It’s important to understand all associated fees and calculate your break-even point. Closing costs, similar to those on your original mortgage, can add up, so ensure the benefits outweigh the expenses.
Here are some other drawbacks to keep in mind:
Increased debt: The new loan amount will be larger than your current mortgage. This increases your debt level even if you were close to paying off the original loan.
Extended repayment: Making extra payments can help you pay off your mortgage faster. Without them, you may end up paying more in interest over time.
Debt spiral risk: Use the cash to pay off high-interest balances and address the spending habits that caused them. Otherwise, you could end up in a worse financial situation.
Foreclosure risk: Since your home is the collateral, falling behind on payments could result in losing your property.
Non-essential spending: Using the funds for things like vacations or luxury purchases can lead to greater debt.
When Is a Cash-Out Refinance a Good Idea?
A cash-out refi can be a smart choice if you need funds for major expenses like home improvements or education. These investments often add value to your life or property. Lower interest rates on the new loan can also reduce your monthly payments. This makes it easier to manage your budget.
Another good time to consider this option is when you want to combine high-interest balances into one payment. Moving these to a loan with a lower rate can save you money over time. Just be sure to avoid using the cash for unnecessary purchases. Staying disciplined with the funds ensures you benefit from the refinance in the long run.
It’s also a good idea if you have built significant equity in your home and want to access it. This can provide financial flexibility for important goals. Always compare the costs and benefits to make sure they match your needs. Taking time to evaluate your situation helps you make the best decision.
How Does a Cash-Out Refinance Work?
Understanding the cash-out refinance process is key to making an informed decision. Start by evaluating whether it aligns with your financial goals. Next, follow these essential steps to prepare for your application.
Obtain Your Free Credit Report Before Applying for a Refinance Loan
Grab a free copy of your credit report before you apply for a loan. Under the Fair Credit Reporting Act (FCRA), you may request one report yearly from Experian, Equifax, and Transunion at no charge.
Review your credit report carefully for errors before applying for a refinance loan. Inaccuracies in the report could lead lenders to deny your application. Contact the reporting agency immediately if this occurs and ask for a correction. The FCRA provides 30 days for the agency to correct the error or explain why it is correct and should stay on your file.
Arrange a Home Appraisal
The amount of your new loan depends entirely on the current value of your home. Most lenders require applicants to obtain a home appraisal no sooner than 90 days before closing. You will need to pay for the home appraisal with your funds.
Compare Cash-Out Refinance Rates and Loan Terms
Compare lenders carefully. A difference of just 0.25% in interest rates can cost you thousands of dollars over the life of the loan. You also want to consider whether the lender offers a fixed or adjustable interest rate.
How Much Cash Can You Get?
The amount of cash you receive from a cash-out refinance depends on your home’s current value and your existing mortgage balance. Lenders typically allow you to borrow up to 80% of your home’s appraised value. For example, if your home is worth $300,000 and you owe $200,000, you could potentially access up to $40,000.
Remember that lenders subtract your current mortgage balance from the new loan amount to determine the cash you’ll receive. The exact amount also depends on your credit score, income, and other financial factors. Reviewing these details with your mortgage lender can help you understand what to expect.
Requirements Needed to Qualify for a Cash-Out Refinance
You’ll need to meet specific criteria the lender sets to qualify. Most require a minimum credit score of 620 and a debt-to-income ratio of 50% or lower. You’ll also need at least 20% equity in your home after the refinance.
Lenders will also ask for proof of income, a recent home appraisal, and a history of on-time monthly mortgage payments. Meeting these requirements shows you’re financially prepared for the new loan. Working with your lender to understand their specific guidelines can help streamline the process.
Closing a Cash-Out Refinance
The closing process for a cash-out refinancing loan is similar to an original mortgage loan. The main difference is that it does not involve another party. You will meet with a lender to sign several documents and remit any outstanding fees. At Listerhill Credit Union, you can complete many of your closing details online, including signing documents electronically.
Cash-Out Refinance Alternatives
A cash-out refinance might not be the best fit for everyone. Listerhill Credit Union offers several options for accessing your home’s equity. Explore these alternatives to find the best solution for your needs:
Home Equity Loan: This option offers a lump sum of money at a fixed interest rate. It works well for one-time expenses like home renovations or major purchases. You’ll repay the loan in consistent monthly installments, often at a lower rate than other borrowing options.
Home Equity Line of Credit (HELOC): A revolving line of credit provides flexibility for ongoing expenses. You can borrow funds as needed during the draw period. With a minimum initial draw of $10,000 and flexible repayment terms, it’s perfect for ongoing projects or expenses. Plus, you’ll enjoy low monthly payments and easy access to your funds.
Both options allow you to access your home’s equity at competitive rates. They come with no annual fees and potentially offer tax-deductible interest. Listerhill Credit Union makes it simple to access the funds you need while keeping costs low.
Next Steps for Your Cash-Out Refinance
A cash-out refinance can be a powerful financial tool when used wisely. It allows you to access your home’s equity for major expenses, debt consolidation, or other financial goals. Lower interest rates and potential tax benefits make it an attractive option for many homeowners.
At Listerhill Credit Union, we’re here to help you confidently navigate the cash-out refinance process. Our team will guide you through the requirements, answer your questions, and ensure you make an informed decision. Ready to explore your options?
Check out our Competitive Rates and Easy Pre-Approval Process
