Cash-Out Refinance: How It Works and When It’s a Good Idea
A cash-out refinance allows you to replace your current mortgage and access a lump sum of cash at the same time. The new mortgage will cover your home purchase and the cash, both of which will be secured by your home. You can use the payout for anything you’d like, from paying off credit cards to remodeling an outdated kitchen.
Key takeaways about cash-out refinances
→ You’re borrowing more than you currently owe.
→ You’ll need more than 20% home equity to qualify.
→ There are tougher requirements to meet than a traditional refinance.
→ You’ll likely have a larger monthly mortgage payment.
What is a cash-out refinance?
A cash-out refinance is when you replace your current mortgage with a larger loan and receive the difference in cash. Two important things to remember:
- The amount you can borrow is based on the amount of equity you have in your home.
- You typically can’t borrow all of your home’s equity.
Lenders calculate your home equity by subtracting your loan balance from your home’s appraised value. They also limit how much of your home’s value can be cashed-out by setting loan-to-value (LTV) ratio requirements. Most lenders set an 80% LTV limit.
Let’s say your home is worth $450,000 and you currently owe $300,000 on your existing mortgage. This means you have $150,000 of home equity.Because most cash-out refinance programs won’t let you borrow more than 80% of your home’s value, two more calculations are required to figure out how much of your equity can be converted to cash:
- First, multiply your home’s value by 80%: $450,000 x 0.80 is $360,000. This is your maximum loan amount.
- Then subtract the balance you owe on your current mortgage: $360,000 – $300,000 is $60,000. This is how much cash you’ll take home after paying off your mortgage.
→ The bottom line: In this case, you can’t borrow more than $60,000 of your $150,000 in home equity.
How to use a cash-out refinance calculator
If mortgage math makes your eyes glaze over, don’t worry — a calculator can do the math for you. Follow these three steps to use LendingTree’s cash-out refinance calculator to find out what your monthly payments could look like:
- Enter your home value. A home value estimator can help you get a rough idea of how much your home is worth.
- Put in your current mortgage balance. You can find this on your most recent mortgage statement.
- Add the amount of cash you’d like to take out. If you enter too large an amount, the calculator will let you know.
How does a cash-out refinance work?
For the most part, a cash-out refinance works like any other home loan. You shop for a mortgage lender, fill out a loan application and qualify based on your credit, income and assets. However, there are a few extra steps involved:
1. You must qualify for a higher loan amount
Because you’re taking out a new loan for more than you currently owe, your lender will need to verify your ability to afford a larger loan amount and higher monthly payment.
2. You’ll pay for a home appraisal
Until a home appraisal is completed, your cash-out refi loan amount is just an estimate. If your appraisal comes back lower than expected, you may not qualify to borrow as much home equity as you’d hoped.
3. Your lender finalizes your cash-out refinance loan amount
Once your appraisal comes back, the lender calculates your cash-out amount by:
- Subtracting your current loan balance from the final loan amount
- Subtracting refinance closing costs from your loan proceeds
4. Your old loan is paid off and you receive the rest of the money in cash
Once you review your closing disclosure to confirm the final figures and sign your closing papers, your lender will fund your loan. Your old mortgage is paid off, the new mortgage is secured by your home and a wire or check is sent to you.
Cash-out refinance requirements
| Conventional | FHA | VA | |
|---|---|---|---|
| Maximum LTV ratio | 80% | 80% | 90% |
| Minimum credit score | 640 | 500 | No minimum (but many lenders require 620) |
| Maximum DTI ratio | 45% | 50% | 41% |
Maximum 80% LTV ratio
A maximum 80% LTV ratio is the standard for both FHA and conventional mortgages. However, there is one major exception: eligible military homeowners can borrow up to 90% of their home’s value with a VA cash-out refinance.
Minimum 640 credit score
Conventional cash-out refinance guidelines require a 640 score. Meanwhile, the VA doesn’t set a minimum score, but many lenders also set their own at 620. FHA loans are the exception, and borrowers may qualify with scores as low as 500.
Learn more about FHA cash-out refinances.
Maximum 50% DTI ratio
Lenders divide your total monthly debt by your income to determine your debt-to-income DTI ratio. They prefer that borrowers not exceed a 43% DTI ratio, but you may be able to go up to a 50% DTI with your cash-out refinance. If you have a high DTI ratio, a high credit score and extra cash in the bank may help your approval odds.
Occupancy
You can only borrow an FHA or VA cash-out refinance loan for a home you will live in as your primary residence. Conventional loans allow you to borrow against equity in a second home or investment property, if you’re willing to borrow less and pay higher rates.
Number of units
You’ll get the most cash out of a single-family home. Lenders apply lower LTV ratio limits to multifamily homes with two to four units.
Property type
Lenders may charge extra fees or higher rates to borrow equity from a condo or manufactured home. Some may even restrict the cash-out LTV ratio on these property types.
Waiting period
If you recently purchased your home, you’ll need to wait 12 months before completing an FHA cash-out refinance. The 12-month waiting period also applies to conventional cash-out refinances, with exceptions possible if:
- You received the property through an inheritance or legal agreement, like divorce or separation
- The property was purchased with all cash
The waiting period is only 210 days (about seven months) if you qualify for a VA cash-out refinance.
Loan limits
Your cash-out refinance loan is subject to conventional and FHA loan limits, which are based on median home prices and change annually. Loan limits don’t apply to most VA loans, though lenders may set their own maximums.
The 2024 loan limits for single-family homes are $766,550 for conventional loans and $498,257 for FHA loans. Ready to compare loan offers on LendingTree?How to get the best cash-out refinance rates
Cash-out refinance rates are generally higher than those offered on regular refinances. Turning equity into debt increases the odds you could lose your home to foreclosure, and lenders pass this risk on to you with higher rates.
Here are four steps you can take to get the best rates:
1. Raise your credit score
Your credit score has a major impact on cash-out refinance rates. A 780 score or higher can get you the lowest rates on a conventional cash-out refinance. Although the minimum requirements are lower for FHA loans, your FHA interest rate is still affected by your credit score.
Pay off credit card balances months before you apply, avoid opening new credit accounts and pay everything on time. The extra effort could save you thousands of dollars in interest charges over a 30-year loan term.
Learn more about how to improve your credit score.
Need help finding or understanding your score? Get help and see your free credit score for LendingTree Spring.2. Borrow less
Your LTV ratio, which measures how much you’re borrowing compared to your home’s value, is another factor that impacts your cash-out refinance rate. The higher your LTV ratio, the higher your rate will be.
One way you can borrow less money and lower your LTV ratio is by paying down your principal balance with a lump sum before refinancing. This can also help make your monthly mortgage payments more affordable.
Read more about how much you should put down on a house.
3. Make home improvements
The right home improvements could increase your home’s value, lower your LTV ratio and lead to a lower cash-out refinance rate. Check Remodeling Magazine’s most recent Cost vs. Value Report to learn which improvements give you the best return on every dollar you invest.
4. Shop around for lender offers
Mortgage shoppers save serious money versus those that don’t shop around, according to LendingTree data. Collect loan estimates from three to five lenders or use an online comparison site and compare the annual percentage rates (APRs) and interest rates to find your best offer.
Check out our list of the best refinance lenders.
Cash-out refinance closing costs: How much you’ll pay
Refinance closing costs typically range from 2% to 6% of your loan amount, depending on your loan size. You’ll pay the same types of fees for a cash-out refinance as a purchase mortgage, which include origination, title, appraisal and credit report costs.
Origination fees and premiums for mortgage insurance are based on a percentage of your loan amount. As such, the more you borrow, the more you’ll spend on these costs.
How are cash-out refinance closing costs paid?
- Conventional cash-out refinances don’t require private mortgage insurance (PMI).
- FHA cash-out refinances come with FHA mortgage insurance regardless of your LTV ratio.
- VA cash-out refinances don’t require mortgage insurance, but you’ll have to pay the VA funding fee of 2.30% to 3.60% of the loan amount.
Cash-out refinance pros and cons
| Pros | Cons |
|---|---|
Flexibility. You can use the funds for any purpose, including consolidating debt, investing in real estate or starting a business. Low interest rates. Mortgages typically have lower interest rates than credit cards, personal loans and home equity loans. Tax advantages. If you use your cash-out refi funds for home improvements, you can deduct the interest you paid over the year when you file your taxes. | 20% equity required. If home values have tumbled in your area or you bought your home with a small down payment, a cash-out refinance may not be possible right now. Loss of equity. Borrowing against your home equity now means a smaller profit when you sell your home later. Higher payments. In most cases, a higher loan amount will mean a higher monthly mortgage payment for as long as you own your home. Added interest. Lenders typically charge higher rates for cash-out refinances than rate-and-term refinances. |
Think a cash-out refinance is right for you?Cash-out refinance vs. HELOC
A home equity line of credit (HELOC) is an alternative way to access cash that’s secured by your home. One advantage of HELOCs is that most HELOC lenders allow you to borrow up to 85% of your home’s value. Some HELOC lenders will even lend up to 100% — much more than the 80% cap on most cash-out refinances.
HELOCs work a lot like a credit card: you can swipe a card to use the funds and pay off those charges as you go. During the “draw period,” which usually lasts 10 years, you can borrow from the credit line, repay it and borrow again as much as you’d like. Once the HELOC draw period ends, though, the repayment period starts. During that time you’ll pay off the balance with regular payments that cover both principal and interest, and you can no longer draw from the credit line.
A HELOC makes sense if:
- You don’t need access to all your funds all at once
- You want an option for interest-only payments
- You want to tap your equity without replacing your mortgage
- You don’t mind borrowing with a variable interest rate
A cash-out refinance makes sense if:
- You need all of the funds at once
- You can benefit from replacing your current mortgage
- You don’t want to juggle multiple payments
- You prefer a stable monthly payment that won’t fluctuate
See current HELOC rates today.
Find out how much home equity you can borrow
Cash-out refinance vs. home equity loan
Another equity-tapping option is a home equity loan, which will give you access to funds secured against a portion of your home equity. You’ll receive all the funds at once and repay the loan on a fixed payment schedule. Terms often range from five to 30 years.
Like HELOCs, home equity lenders may set LTV ratios up to 100%, though most keep the maximum at 85%.
A home equity loan makes more sense if:
- You need to borrow more equity than cash-out refinance programs allow
- You don’t want to replace your current mortgage
- You don’t mind making two monthly mortgage payments
A cash-out refinance makes more sense if:
- Your credit scores are too low to qualify for a home equity loan
- You only want to have one monthly payment
See current home equity loan rates today.Frequently asked questions
Yes, FHA cash-out refinances are a legitimate loan product insured by the Federal Housing Administration (FHA).
Yes, if you qualify. However, you’ll be limited to a lower LTV ratio and should expect a higher interest rate. Lenders limit the LTV ratio for cash-out refinances on investment properties to 75%, meaning you’ll need at least 25% equity after closing.
Yes, you may qualify to take out equity on a second home, but you’ll be subject to the same lower LTV limits as investment property cash-out refinances.
The amount of cash you can borrow depends on your chosen loan program’s maximum LTV ratio. For example, you can borrow up to 80% of your home’s value with a conventional cash-out refinance.