A cash-out refinance is a good way for homeowners who have equity in their homes to refinance the mortgage and get a lump sum in cash at the same time. But a cash-out refinance isn’t free money or free of risk, so homeowners should consider the pros and cons before they decide.
A cash-out refinance is like any other refinance, except the cash-out refinance replaces an existing loan with a new loan for a higher amount.
For example, if your house was worth $200,000 and you had a $110,000 first mortgage and no second mortgage, your equity would be $90,000.
If you refinanced with a new $150,000 loan, you would pay off the existing $110,000 loan and get $40,000 — less any points, loan origination fees and closing costs — in cash. You could use that cash to make repairs to your home or for any other purpose.
You won’t be able to get the full $90,000 in cash because the lender will want you to keep a cushion of at least some equity, in case your house declines in value.
The point may be obvious, but if you have negative or no equity in the home, you won’t be able to get a cash-out refinance.
Benefits and risks of cash-out refinance
A cash-out refinance usually has a lower interest rate than a home equity loan, home equity line of credit, business start-up loan or credit card. That means a cash-out refinance can be a more affordable way to borrow a large sum of money.
A cash-out refinance is a loan, so you’ll have to fill out a loan application, qualify and pay the closing costs.
A cash-out refinance is secured by your home, which means if you don’t make the payments on the loan, you could lose the home.
If the value of your home declines, you could have negative equity, which is also referred to as being “underwater” or “upside down” on the loan. If that happens, it could be difficult to refinance, obtain a second home loan or sell the home.