A cash-out refinance allows you to shake some money out of your home’s equity by borrowing more than you owe.
It’s a popular move. More than half of homeowners who refinanced during the first quarter of 2017 cashed out some equity, according to a report from Black Knight Financial Services.
A cash-out refi has obvious benefits, particularly if you need to get your hands on a pile of money and have equity in your home. But there are also costs — and one very serious risk.
Here are answers to frequently asked questions about cash-out refis.
1. How does a cash-out refinance work?
It all comes down to how much your home is worth, your current mortgage balance and how much you want to borrow.
Say you paid $200,000 for your house. You’ve been in the home for a while and have paid the principal down to $150,000.
An appraisal shows the home is now worth $300,000.
With a cash-out refinance, lenders typically make loans for 70 to 80 percent of home value. Eighty percent of $300,000 home would be $240,000.
Opt for that maximum loan amount, and you can “cash out” the difference between your new $240,000 mortgage and the $150,000 balance on the old one: $90,000.
Closing costs and fees can be rolled into the new mortgage, or you can have them deducted from what you’ll be cashing out in equity.
2. Why do homeowners tap equity?
You can use the money from a cash-out refinance any way you want. Two of the most common reasons homeowners tap their home equity are:
- To pay for remodeling projects and other home improvements.
- To reduce or consolidate higher-interest credit card debt.
Homeowners also use them to fund continuing education, vacations and businesses.
3. What are the benefits?
Cash-out loans offer several benefits. You can obtain a larger sum of money at once. Interest is in the mortgage-rate range, rather than the credit card range – which can be a difference of 10 to 20 percent annually. And the interest you do pay is tax-deductible.
4. How much cash can I get?
While lenders typically make cash-out refinance loans for up to 80 percent of the home’s value, that threshold can vary.
With FHA cash-out refinance loans — that is, refi loans that are insured by the Federal Housing Administration — lenders can go as high as 85 percent. And VA-backed cash-out refinance loans are available for up to 100 percent.
Your credit rating also is a factor. “The higher the loan-to-value, the better their credit score needs to be,” says Staci Titsworth, vice president and regional sales manager for PNC BANK.
So if someone with a 740 FICO score could likely borrow the maximum loan-to-value, a homeowner with a 680 score could be restricted to a threshold 5 to 10 percent lower, says Ann Thompson, divisional sales executive for Bank of America.
5. How do I know what the house worth?
One of the first steps in a cash-out refi is a home appraisal.
Expect it to take from an hour to an hour-and-a-half and cost between $400 to $650. For high-dollar homes and larger properties, it could be as much as $1,300.
Because of the appraisal costs, there is often an upfront deposit for a cash-out refinance loan. And no matter the outcome of the appraisal, the fee is often non-refundable, Titsworth says.
6. What are the rates and fees?
With a cash-out refinance, you’ll pay closing costs similar to what you’d expect for a regular home sale. Like your original mortgage, you want to compare rates and closing costs. And, like an original mortgage, they’ll typically run from 0.8 to 1.3 percent, according to a 2017 Bankrate study.
Some lenders quote a base interest rate and give you the option of buying that rate down by paying points (fees equal to 1 percent of your loan balance). So before you marvel at super-low rates, ask if that includes any points — and what that rate would be without them.
Within a few days of applying, each lender will supply you with a loan estimate form — what used to be called the “good faith estimate.” This is basically the Schumer box for your prospective loan, and it tells you exactly what your cash-out refinance loan will cost.
7. There are risks
While using the home to finance home repairs or upgrades can make economic sense, cashing out home equity to pay off credit card or other debt is often a bad move.
With a credit card, there is no collateral for creditors to take if you default. But with a cash-out refi, the collateral is your home.
Trade card debt for a mortgage you can’t pay and you could lose your house.
Consider your long-term financial goals, too.
Once you’ve tapped home equity, you won’t be able to do it again for a long time. And if you’re borrowing to fund an ongoing financial problem (like credit card debt) before resolving the underlying issues, you’re just digging the hole deeper.