What Is a Cash-Out Refinance and How Does It Work?

What Is a Cash-Out Refinance and How Does It Work?

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With today’s refinance rates sitting near record lows, many homeowners are finding that it’s a good time to refinance. But your new loan doesn’t have to match the amount you owe on your existing mortgage. If you need to borrow money for other purposes, like financing home improvements, you can look at doing a cash-out refinance. Here, we’ll explain how a cash-out refinance (also called a cash-out refi) works and whether it’s a good idea.

What is a cash-out refinance?

When you refinance a mortgage, you swap your existing home loan for a new one, usually at a lower interest rate. Specifically, your old loan is paid off and you then make a monthly payment on your new loan.

With a regular refinance, your new loan equals the amount left on your old mortgage loan. But with a cash-out refinance, you borrow more than your old mortgage balance and receive the remainder in cash form (or, to be more technical, you get a check for the rest).

To be eligible for a cash-out refinance, you need to have enough home equity to borrow more than what’s left on your mortgage. (Your home equity is the portion of your home you own. In other words, it’s the amount your home is worth minus what you owe on your mortgage.) You also need to have a good credit score, a relatively low debt-to-income ratio, and a steady job. These are requirements for a regular mortgage refinance too, but they’re especially important for a cash-out refinance because you’re borrowing extra.

How does a cash-out refinance work?

Say you owe $200,000 on your mortgage, but you decide to refinance to a new loan with a lower interest rate. With a cash-out refinance, you might decide to borrow $240,000. The first $200,000 of that loan would go to pay off your existing mortgage, and you’d get a check for the remaining $40,000.

You’ll pay closing costs in the course of refinancing. Usually, closing costs equal 2% to 5% of the amount of your loan, but it depends on the lender. With a cash-out refinance, you can expect your closing costs to fall into that same range. However, keep in mind that it’ll cost more to close on a cash-out refinance than a regular refinance because you’re borrowing more money.

When is a cash-out refinance a good idea?

A cash-out refinance could be a good way to borrow money affordably, since the interest rate on your mortgage may be a lot lower than what you’ll pay on a home equity loan or HELOC (home equity line of credit).

But remember, with a cash-out refinance, your monthly mortgage payment could increase despite scoring a lower interest rate payday loans Tipp City, OH online because you’re borrowing more. That could make those payments harder to keep up with.

You may want to do a cash-out refinance if you have home repairs or improvements you need to finance. You can also do a cash-out refinance as a form of debt consolidation. If you have credit card debt, for example, you can use the money from your cash-out refinance to pay it off, and then repay your new mortgage at a lower interest rate.

If you’re thinking of doing a cash-out refinance, use a mortgage calculator to figure out what your new monthly payment will look like, and make sure you can really afford it. Also, if you’re refinancing, be sure to shop around with different mortgage lenders. Each lender sets its own rate and closing costs, so comparing several offers is a good way to make sure you end up with the best deal.