What is a cash-out refinance?
– A cash-out refinance replaces your existing mortgage with a new, larger mortgage, pays off the old loan, and delivers the difference to you in cash. In effect, you convert part of your home’s equity (the portion of the home you own outright) into liquid funds while keeping your mortgage secured by the property.
Key definitions
– Home equity: current market value of the home minus the outstanding mortgage balance.
– Loan-to-value (LTV) ratio: the mortgage balance divided by the home’s market value (expressed as a percentage). Lenders use LTV to limit how much you may borrow.
– Rate-and-term refinance: replacing a mortgage to change the interest rate or loan term without taking cash out.
– Home equity loan / HELOC: separate products that borrow against equity without replacing the first mortgage (home equity loan = fixed lump sum; HELOC = revolving line of credit).
How a cash-out refinance works (step-by-step)
1. Decide how much cash you need and why you need it (debt consolidation, home improvements, emergency funds, etc.).
2. Check how much equity you have: Equity = Home value − Current mortgage balance.
3. Learn your lender’s maximum LTV for cash-out refinances (commonly up to ~80% for conventional loans).
4. Apply for the refinance: lender evaluates credit, income, property value (usually via appraisal), and existing mortgage.
5. If approved, the new mortgage pays off the old mortgage; the difference (less closing costs and fees) is paid to you at
closing. That cash is paid either by check or deposit to your account and is usually disbursed at the mortgage closing/settlement table after the old loan is paid off and title is transferred to the new lender.
Pros (why borrowers choose cash‑out)
– Access to a large lump sum using relatively low‑cost housing collateral compared with unsecured credit.
– Potential to consolidate higher‑interest debt (credit cards, personal loans) into a single, lower‑rate mortgage payment.
– Can fund substantial home improvements that may increase property value.
– Possible access to better mortgage terms (fixed rate instead of adjustable) or to lower monthly payments by extending the loan term.
Cons and risks
– You increase your mortgage balance and reduce home equity; this raises the risk of owing more than the home is worth if prices fall.
– You restart or extend the mortgage amortization schedule, often increasing total interest paid over the life of the loan.
– Closing costs and fees can be several thousand dollars (typically 2–6% of the new loan), which reduce the net cash received.
– Interest may not be tax‑deductible depending on how you use the cash and current tax law; consult the IRS or a tax advisor.
– Using funds for consumption (vacations, luxury goods) can worsen your long‑term financial position.
Eligibility and typical limits
– Loan‑to‑value (LTV) limit: conventional cash‑out refinances commonly cap LTV near 80% of appraised value. Government programs (e.g., FHA or VA) have different rules and limits.
– Credit score, debt‑to‑income (DTI) ratio, employment history, and payment history on the existing mortgage all affect approval.
– Lenders generally require an appraisal and title search; some programs impose seasoning requirements (minimum time since prior mortgage).
Costs and fees to expect
– Appraisal fee.
– Origination fee (percentage of the loan or flat).
– Title insurance and escrow
– Title insurance and escrow fees. These cover the lender’s and borrower’s protection against title defects and the administration of closing.
– Mortgage‑insurance premiums (MIP) or private mortgage insurance (PMI). If your new loan’s loan‑to‑value (LTV) ratio is above the lender’s PMI threshold (often 80% LTV for conventional loans), expect upfront or ongoing mortgage‑insurance costs. Government programs (FHA, VA) have different insurance/fee structures. Define: private mortgage insurance (PMI) — insurance that protects the lender if you default; it does not protect you.
– Recording and transfer taxes. Local government charges to record the new mortgage and deed.
– Prepaid items. These include property tax escrows, homeowners insurance escrows, and prepaid interest from closing until the next payment date.
– Payoff fees on the old mortgage. Some lenders charge a payoff statement fee or prepayment penalty if your current loan has one.
Typical ranges and how to think about them
– Closing costs (excluding mortgage insurance) commonly run about 2%–5% of the new loan amount. That range depends on state fees, lender pricing, and whether you roll fees into the loan.
– Appraisal fees often run $300–$700 for a single‑family home but vary by market and property complexity.
– PMI for conventional loans may be 0.3%–1.5% of the loan annually (varies widely); FHA’s MIP has its own upfront and annual schedules. Check program specifics.
How the cash‑out amount is calculated (formulas)
– Maximum allowable new loan = Appraised value × Max LTV (e.g., 0.80 for 80% LTV).
– Available cash before costs = Maximum allowable new loan − Existing mortgage balance.
– Net cash to you after closing = Available cash before costs − Closing costs − Upfront mortgage insurance (if any) − Any payoff penalties.
Worked numeric example
– Home appraised value = $400,000.
– Lender’s max LTV for a cash‑out refi = 80% → Maximum new loan = 0.80 × $400,000 = $320,000.
– Current mortgage balance = $200,000.
– Available cash before costs = $320,000 − $200,000 = $120,000.
– Estimated closing costs (3% of new loan) = 0.03 × $320,000 = $9,600.
– Upfront mortgage insurance = $0 (assume LTV ≤80%).
– Net cash to borrower = $120,000 − $9,600 = $110,400.
Step‑by