For homeowners looking to convert home equity into cash, a cash-out refinance can be a great option. Interest in these refinances has soared in the pandemic as home values have hit record highs and homeowners’ equity has jumped. According to CoreLogic, the average annual home equity gain was $26,300 by the fourth quarter of 2020 compared to the same quarter in 2019. But before you decide whether a cash-out refi is right for you, make sure you understand how the refinancing process works in general. To help you get started, here are answers to top questions about cash-out refinances.
What is a cash-out refinance?
A cash-out refinance replaces your current mortgage with a new home loan with a higher balance, and you receive some of the difference in cash. With a cash-out refinance, a homeowner is taking advantage of equity they’ve have built in a home, and the money they get back in cash is part of that equity.
For example, let’s say you own a house that recently appraised at $300,000. You have paid down the mortgage to $150,000, which means you have $150,000 in equity in the house. If you were to opt for a cash-out refinance, you could take out some of that $150,000 in equity as cash.
How much equity can I cash out?
Many factors go into how much of the equity you can take, including:
- Your loan type: Most cash-out refinance lenders limit the amount of equity homeowners can take out of their homes. As an example, Fannie Mae, Freddie Mac, and Federal Housing Administration (FHA) cash-out refinance loans require homeowners to leave 20% equity in their homes (the same as a 20% down payment). In other words, the maximum loan-to-value (LTV) ratio for these refinances is 80%. In contrast, Veteran Affairs (VA) loans might allow a LTV ratio of 90%, meaning 10% equity would have to remain in the home.
- Your credit score: Lenders typically have their own internal credit score ratings to evaluate borrowers so credit score requirements vary. Generally, the higher your score, the more financing options you tend to have as a borrower.
- Your debt-to-income (DTI) ratio: Your debt-to-income ratio is the sum of your monthly debt payments divided by your monthly gross income. Maximum DTI will vary by lender and loan program, but it generally ranges between 40% and 50%.
- Your payment history: Lenders typically look for borrowers with good payment histories. If you want to qualify for a cash-out refinance, it’s important that your present home loan is current and that you have no late payments in the last 12-months.
How can I use cash from a cash-out refi?
You can use the money from a cash-out refinance any way you want. Some common uses include:
- Paying cash for home renovations or repairs (learn more here)
- Paying off student loans or college tuition
- Paying off credit card, auto, or personal loan debt
- Building retirement savings or an emergency fund
- Consolidating debt
Debt consolidation is one of the most popular uses given that you can apply a low mortgage rate to high-interest, non-mortgage debt—like credit cards—as you consolidate. Depending on the source, average credit card rates reportedly range from about 14–20% compared to 30-year fixed mortgage rates which are currently averaging around 3%.
- Learn about debt consolidation and cash-out refinances in our blog here.
- Learn about cash-out refinances and renovations here.
What are the disadvantages of cash-out refinances?
Some disadvantages include that:
- Your mortgage balance will go up.
- You’ll have to pay closing costs, depending on your loan type, which generally add 2–5% to a loan’s amount.
- Mortgage debt often has higher finance charges than car or credit card debt, for example. Keep this in mind if you plan on consolidating or paying off debt.
- It may take longer to pay off your home, depending on your loan term.
- Cash-out refinances are a secured debt (your home is the collateral), in contrast to credit cards and unsecured personal loans, so there’s a foreclosure risk if you can’t afford your payments.
- Your mortgage may be worth more than your house if home prices drop.
What are the benefits?
Some benefits include that:
- You can pull equity out of your house without selling it.
- Your DTI could go down and your credit score could go up as you pay off debts or consolidate them.
- You may be able to refinance to a lower mortgage rate.
- You may be able to eliminate private mortgage insurance (PMI), if you’re paying it now.
- You can shorten or lengthen your loan term to adjust your payments.
Ready to cash in on a cash-out refi? Visit www.mrcooper.com/refinance to learn more.
*A cash‐out refinance increases your mortgage debt and reduces the equity you may have in your home. Your monthly mortgage payments may be higher. A debt consolidation refinance increases your mortgage debt, reduces equity, and extends the term on shorter‐term debt and secures such debts with your home. The relative benefits you receive from debt consolidation will vary depending on your individual circumstances. You should consider that a debt consolidation loan may increase the total number of monthly payments and the total amount paid over the term of the loan. To enjoy the benefits of a debt consolidation loan, you should not carry new credit card or high interest rate debt.
Tradenames and trademarks used in this blog post are the property of their respective owners. Nationstar Mortgage LLC d/b/a Mr. Cooper is not affiliated, associated, or sponsored by any of these owners. Use of these names and trademarks is not intended to and does not imply endorsement, but is for identification purposes only. Information provided does not necessarily represent the views of Mr. Cooper. Information is subject to change without notice.