What You Should Know
- A cash-out refinance lets you borrow a large amount of money at a low interest rate
- The difference between your refinanced mortgage amount and your old mortgage amount is the additional amount that you are borrowing
- You can borrow up to 80% of your home’s value with a cash-out refinance
- Cash-out refinances are usually used for debt consolidation, home improvements and renovations, and investments
- There can be significant penalties for a cash-out refinance that is done before the end of your mortgage term
Cash-Out Refinance Explained
The difference between your new mortgage amount and your old mortgage amount can then be “cashed out” in cash. In other words, a cash-out refinance lets you borrow money using your home equity through your mortgage. Cash-out refinances are sometimes referred to as equity take-out.
How Does a Cash-Out Refinance Work?
How a cash-out refinance works is that you are replacing your existing mortgage with a larger mortgage. After paying off your existing mortgage, you will have money left over that you can then use. The amount that you can borrow with a cash-out refinance will depend on how much home equity you have.
Your home equity is based on the value of your home and the size of your mortgage. You will need to get a home appraisal since your lender will only consider the appraised value of your home. The difference between your home’s value and any debt tied to your home, such as your mortgage, is the equity that you have in the home. That’s because you will need to pay off this debt when you sell your home, so the amount remaining is your equity. You can use your home equity to borrow money by using your home as collateral. This lets you access your home equity without needing to sell your home. Otherwise, you will only be able to get access to your home equity when your home is sold.
Over time, as you continue to make mortgage payments, your mortgage balance will decrease. This increases your home equity if your home value stays the same. However, your home value also affects your home equity. If the value of your home increases, then your home equity also increases. That’s because if you were to sell today, you will be able to get a higher selling price while the mortgage debt tied to the home stays the same. If home values decrease, then your home equity will also decrease. It’s possible for your home equity to decrease even when you are making regular mortgage payments during instances where your home value decreases more than your mortgage principal payments.
With a cash-out refinance, you can borrow up to 80% of the value of your home. This includes both the mortgage balance and the amount that you want to cash out and is also referred to as your loan-to-value (LTV) ratio. The higher your loan compared to the value of your home, the higher the LTV ratio.
Cash-Out Refinance vs Refinance
The difference between a cash-out refinance and a refinance is the amount that you are borrowing. With a regular refinance, your new mortgage will be for the same amount as your existing mortgage. The only change might be your mortgage rate. If your new mortgage rate is lower, you will be saving money through lower mortgage interest payments. With a cash-out refinance, you are increasing your mortgage balance amount, in addition to other possible changes such as your mortgage rate. Since you are borrowing more money, your mortgage payments might also be larger.