If you’ve been paying down your mortgage for some time or your home’s value has gone up significantly, you could take advantage of that equity with a cash-out refinance. This process refinances your current mortgage to a bigger loan with additional funds from your equity.

How a cash-out refinance works

A cash-out refinance is a financial tool that allows you to withdraw some of your home’s equity as cash you can use for any purpose. When you do a cash-out refinance, you replace your existing mortgage with another loan for a larger amount, which includes the remaining balance of your mortgage and the amount you cashed out. Ideally, the new loan has a lower interest rate.

Here’s a simple scenario: Let’s say you have about $260,000 left on your mortgage and your home is worth $410,000. That means you have $150,000 in equity. For most cash-out refinances, mortgage lenders require you to maintain 20 percent equity in your home — in this case, $82,000. So, if you did a cash-out refinance, you could tap up to $68,000 of your equity. Add to that the $260,000 balance from your old mortgage, and you’d be borrowing $328,000 with your new loan.

You might also decide to finance the closing costs for the new mortgage. If you roll these into the loan, you’ll have a bigger balance to repay, along with more in interest charges.

Keep in mind: You don’t have to cash out all of your tappable equity, and you shouldn’t do this type of refinance unless you have a specific goal for the funds, such as a renovation that’ll add value to your home or education to advance your career. Be realistic with yourself if you plan to use the funds to pay down debt. If the circumstances or habits that first got you into debt are still in place, you might end up digging yourself deeper — now with your home on the line.

Cash-out refinance requirements 2022

  • Cash-out refinance credit score: Many mortgage lenders look for a credit score of at least 620, although depending on the loan program, you might get away with a score as low as 580.
  • Cash-out refinance debt-to-income (DTI) ratio: The DTI ratio compares your debt payments against your monthly gross income. For a cash-out refinance, lenders like to see a ratio no higher than 43 percent on the new loan, but some do go up to 50 percent. Others stick to a lower DTI ratio closer to 40 percent.
  • Cash-out refinance equity requirements: For most cash-out refinances, you’ll need to retain at least 20 percent equity in your home. If you’re eligible for a VA cash-out refinance, however, you can take out the full 100 percent of your equity  — no cushion needed.

In addition, your lender will likely order an appraisal of your home. The appraisal determines your home’s value, which is necessary to know before you can cash out.

Like any other mortgage, your lender will also want evidence of employment and income to ensure you can repay the new mortgage. Here’s more on what to expect for a loan application.

Learn more about cash-out refinancing: