A cash-out refinance allows you to tap your home equity and access cash for financial goals such as a home remodel or college tuition. However, the cash you’ll get isn’t free money, and in fact, you’ll likely have to pay more in interest on the mortgage.
Are cash-out refinance rates higher?
While the difference isn’t extraordinary, cash-out refinance rates are typically higher than their rate-and-term counterparts. This is because mortgage lenders consider a cash-out refinance relatively higher-risk, since it leaves you with a larger loan balance than you had previously and a smaller equity cushion. In addition, lenders might view taking out cash as a method of masking serious financial issues, like overwhelming debt or impending job loss.
The difference between a cash-out and no-cash-out refinance rate also depends on the type of loan. For example, FHA loans don’t have a risk adjustment between purchases and refinances, so the rate will be determined by your loan-to-value (LTV) ratio and credit score (more on what factors into your rate below).
How much higher are cash-out refinance rates?
For a borrower with good credit doing a cash-out refinance on a loan tied to a primary residence, the cash-out refi rate is generally one-quarter to one-half percentage point higher than the rate on a rate-and-term refinance, says Greg McBride, CFA, chief financial analyst at Bankrate.
“This can fluctuate depending on market conditions, and could be higher,” says McBride.
If you retain more equity after the refinance, the rate difference might not be as drastic.
The more equity you have, the more incentive you have to make the payments because that is your skin in the game
— Greg McBrideChief Financial Analyst at Bankrate
“More equity reduces the risk to the lender because they’re funding less of the overall property cost and in the event of default, there is a margin of safety before they take a loss.”
How cash-out refinance rates are determined
To determine cash-out refinance rates, mortgage lenders take a baseline interest rate and then make adjustments based on your credit score and LTV ratio. Having a higher credit score and lower LTV ratio will help you score a more favorable rate.
Other factors, such as economic conditions (including inflation) and the lender’s overhead, influence your interest rate, as well. The movement of the 10-year Treasury, specifically, is linked to the movement in fixed mortgage rates.
Tips to get the best cash-out refinance rate
Raise your credit score
“As with any mortgage refinance, you’ll get the best terms with a credit score of 740 or better,” says McBride, “but borrowers with credit scores of 680 to 739 can still get very competitive rates, particularly if they comparison-shop different lenders.”
First, check your credit report (for the remainder of 2022, you can do this for free every week with each of the three credit bureaus, Equifax, Experian and TransUnion, at AnnualCreditReport.com). Take note of your score, but also look for any incorrect information. For example, someone else’s account information might be on your report by mistake, or there could be incorrect contact info. If you spot an error, contact the credit bureau as soon as possible to resolve it. Ideally, you should do this well before you apply for a refinance.
If your score itself could use some work, strive to pay all your bills on time, pay down debt (it helps to focus on the debt with the highest monthly payments, as this affects how much you could potentially be approved for) and avoid opening any new lines of credit.
Maintain a lower LTV ratio
You’ll be a more attractive borrower overall if you can keep a lower LTV ratio after the refinance.
“Someone with a million-dollar home withdrawing $100,000 in cash but with an LTV of 40 percent is seen as much less risky than a borrower taking out $25,000 but with an LTV of 80 percent,” says McBride.
Purchase discount points
Most lenders allow you to buy discount points to reduce your interest rate. One point generally costs 1 percent of the loan amount and cuts your rate by 0.25 percent.
However, buying points isn’t all upside.
“Keep in mind that paying points will reduce the amount of cash you’re actually getting on a net basis from the cash-out refi,” says McBride.
If you choose to finance points with your loan, rather than paying for them upfront at closing, you’ll also be paying more in interest.
The decision to buy points usually comes down to how long you plan to stay in your home. If you plan to move soon, you likely won’t have a chance to break-even or recoup the cost of the points via the savings on your monthly payment.
Because cash-out refinances are a riskier proposition, they tend to have higher interest rates compared to a no-cash-out refinance. Still, there are still steps you can take to receive a more competitive rate, including improving your credit, keeping your LTV ratio low and buying points. Shop around for quotes, too, starting with your current bank or lender, then at least two other lenders. This can help you land the lowest possible rate.