Cash-Out Refinance: How It Works and When to Get One

A cash-out refinance replaces your old mortgage with a new, larger loan. You pocket the difference and pay down the new loan over time.

When you own a home, you build equity over time by making payments toward the principal and letting the market value naturally appreciate. The downside? Your equity is typically locked up until you sell the property. However, with a cash-out refinance, you can tap into your home equity without having to move.

While there are many benefits to getting a cash-out refinance, it isn’t always the best way to access your home equity.

What is a cash-out refinance?

A cash-out refinance is a type of mortgage refinance that allows you to take out a loan for more than you owe on your current mortgage. The lender hands you the difference in cash, minus closing costs. You pay back the new loan over time, usually between 15 and 30 years. Your home acts as collateral on the loan, just like with a regular mortgage.

How does a cash-out refinance work?

A cash-out refinance replaces your existing mortgage with a new, larger mortgage. You get the difference as a lump sum of cash, usually through a wire transfer to your bank account after closing. You can use the cash for any purpose, but popular uses include debt consolidation and home improvements.

There’s usually a “seasoning” requirement, which is a period you’ll need to wait between closing on your first mortgage and getting a cash-out refinance. The seasoning requirement depends on the type of mortgage you have.

Conventional loans: You’ll need to own the home for at least six months.
VA loans: You’ll need to wait at least 210 days from the first payment or make at least six payments on the loan, whichever is longer.
FHA loans: You’ll need to live in the home for at least 12 months before applying for a cash-out refinance.

The amount you can borrow depends on your home’s value, mortgage balance and credit score. You’ll typically need a loan-to-value ratio (LTV) of at least 80% after the cash-out refinance.

For example: Let’s say you bought your house for $250,000 and you’ve paid your mortgage down to $150,000. Your house has appreciated and is now worth $300,000. Your equity is 50%, or $150,000.

Lenders generally only allow you to borrow against 80% of your home’s value, so, in this case, you’ll be able to get a new loan for $240,000 and cash out $90,000.

That maximum loan amount will also need to cover closing costs, like administrative expenses and appraisal fees.

Pros and cons of cash-out refinancing

A cash-out refinance allows you to borrow a potentially large amount of money, usually at a lower interest rate than unsecured loans. But you’ll drain your equity in the process, and you may be at a higher risk of foreclosure if you can’t afford your increased monthly payments.

Before pursuing a cash-out refinance, consider the following benefits and drawbacks:

Pros

Lower rate than home equity loans
Restarts your mortgage term
Can decrease your mortgage rate

Cons

Higher closing costs due to larger loan amount
Large loan amount
May take longer to become debt-free

Calculating how much you can borrow

To find out how much you can borrow with a cash-out refinance, start by checking your home’s market value and your mortgage balance. Lenders usually require you to have at least 20% equity in your home after closing on the cash-out refinance, which limits how much you can borrow.

Here’s a step-by-step guide for crunching the numbers:

Calculate your home equity. Subtract your mortgage balance from your home’s market value.

$300,000 – $150,000 = $150,000

Find your mortgage balance. Multiply your home’s value by your maximum LTV ratio. Keep in mind that most lenders will only allow you to borrow against 80% of your home’s value.

$300,000 x 0.80 = $240,000

Figure out how much cash you’ll receive. Subtract your current mortgage balance from the maximum mortgage balance allowed by your lender.

$240,000 – $150,000 = $90,000

Our home loan borrowing calculator can help out with that.

What are the eligibility requirements for a cash-out refinance?

To get a cash-out refinance, lenders usually require:

Home equity of at least 20%
An LTV ratio of no more than 80%
A current appraisal of your home to verify its value
A credit score of at least 620
A debt-to-income ratio (DTI) of 43% or less, including the new loan
Verification of your income and employment

Don't forget:

Seasoning requirements vary by loan type. Depending on the type of loan you have, you will need to own the home for a certain period of time to qualify.

Cash-out refinance rates

Today’s cash-out refinance rates are still near historic lows. However, these rates can be as much as 0.5% higher than a traditional mortgage refinance since you’re tapping your home equity.

Several factors impact your cash-out refi rate, such as:

Credit score: A higher credit score can help you qualify for a lower mortgage rate.
LTV: A lower LTV can reduce your rate if you don’t access all of your available home equity since you’re borrowing less.
Repayment term: Longer repayment lengths have a higher interest rate but a lower monthly payment.
Closing costs: Your lender may allow you to roll your closing costs into the loan. Unfortunately, this choice increases your APR and total amortization.
DTI: A higher DTI poses more risk and a lender may not approve your application. Strive to have a DTI of 36% or less before you apply with a conventional mortgage lender.

With a cash-out refinance, you’ll pay the same interest rate on your existing mortgage principal and the lump-sum equity payment. Most lenders offer fixed interest rates so you can easily calculate your monthly payment.

5 steps to get a cash-out refinance

The steps to getting a cash-out refinance are similar to the process of getting your first mortgage. You’ll check the lender’s requirements, determine how much you want to borrow, and apply with the lender you choose.

Compare lenders: Every lender has its way of setting borrowing requirements, interest rates and closing fees, so it’s a good idea to shop around. Compare offers from at least three lenders before making your choice.
Check your lender’s eligibility requirements: Ask about the minimum credit score, maximum DTI and maximum LTV to see if you’re eligible for a cash-out refinance.
Determine how much cash you want to borrow: Your lender may approve you for a certain amount, but you don’t have to borrow the max. Consider how much you need based on how you’ll use the funds.
Fill out the application and go through underwriting: Once you’ve chosen a lender, fill out the loan application and submit your supporting documents. The lender will review these materials and order a home appraisal.
Close on the loan: On closing day, you’ll sign the loan documents and get a check for the “cash out” portion of your loan.

The best way to know how much a cash-out refinance would cost you is to get quotes from multiple lenders. You can get prequalified offers from Credible in just a few minutes — checking rates with us is free and won’t impact your credit score.

Cash-out refinance vs. home equity loan

A cash-out refinance and a home equity loan are two different ways to access your home equity with a fixed interest rate.

As previously discussed, cash-out refinancing lets you take out a new mortgage that’s worth more than your existing mortgage and receive the difference in cash. You might consider this option if you want to reduce your interest rate or change your repayment terms.

Home equity loans are second mortgages and, as such, don’t modify your existing mortgage. While there are more restrictions regarding how you can use your equity, this option can be better if you don’t want a new interest rate or repayment terms.

Expert tip:

“While a cash-out refinance might make sense if you need to fund large expenses, it’s a large loan with a potentially higher rate than other types of refinancing, so it might not make sense for everyone.” — Reina Marszalek, Senior Editor, Mortgages

More alternatives to cash-out refinance

If you’re not sure a cash-out refinance is right for you, consider these alternatives:

Scenario	Consider this financing option
Home renovations	Cash-out refinancing
Debt consolidation	Cash-out refinancing
Education expenses	Home equity loan
Short-term cash needs	Personal loan
Recurring cash needs	Home equity line of credit (HELOC)

Frequently asked questions

Is it hard to qualify for a cash-out refinance?

To be eligible for a cash-out refinance you’ll typically need a 620 (or higher) credit score, an LTV ratio of no more than 80%, at least 20% home equity, and a DTI of 43% or less. You will also need to own the home for a certain period of time but that will vary depending on the loan type.

Can you pull equity out of your home without refinancing?

Yes, there are two common alternatives to refinancing: HELOCs and home equity loans. A HELOC is similar to a credit card in that XYZ while a home equity loan is XYZ

Does a cash-out refinance hurt your credit?

Refinancing a mortgage can temporarily lower your credit score due to the hard credit pull and an increase in credit history length but most homeowners won’t see more than a nominal difference. To avoid seeing a more significant drop in your credit score you should make payments on time and avoid missing payments if possible. Payment history accounts for more than one-third of your FICO score so it’s particularly important to stay on top of it.

Amy Fontinelle contributed to the reporting for this article.

Meet the expert:

Kat Tretina

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Kat Tretina has been a personal finance writer for more than eight years, specializing in mortgages and student loans. Her work has been featured by Buy Side from WSJ, U.S. News & World Report, Yahoo Finance, and MSN.