A cash-out refinance basically converts the equity you’ve built up in your home into cash. The loan proceeds can be used to consolidate high-interest debt, make much-needed home improvements, meet other financial goals or, however, else you see fit.
But is it the right option for you? While there are many reasons a cash-out refinance could be suitable, there are also cons to consider. Here’s a breakdown of how this mortgage product works and the advantages and disadvantages you’ll need to assess to make an informed decision.
Home Loans and Mortgage Refinancing
How Does a Cash-Out Refinance Work?
To demonstrate how a cash-out refinance works, assume your home is valued at $450,000, you owe $275,000 on the mortgage, and the lender has agreed to let you borrow 80 percent of your home’s value.
At closing (or shortly after closing), you’ll get $85,000 in cash ($450,000 * .80 – $275,000). Your current mortgage with a balance of $275,000 will be replaced with a new mortgage for $360,000 ($275,000 + $85,000).
Benefits of a Cash-Out Refinance
Cash-out refinances offer many perks to homeowners.
May Get Lower Interest Rate
Since you’ll swap out your current mortgage with a new one, you could get a lower interest rate and save several hundred or thousands of dollars in interest over the loan term. It depends on how much cash you pull out, though.
Consolidate Higher Rate Loans into One
You could use the loan proceeds to streamline the repayment process so you won’t have to pay several creditors each month. Furthermore, you could save a sizable amount in interest than you would have if you only made the required minimum monthly payments.
Free Up Cash for Major Improvements
Home improvements can place a dent in your wallet. Or you could spend months or even years saving up the funds needed to cover the costs. But by tapping into your home’s equity through a cash-out refinance, you’ll have the cash required to pay for expenses and labor right away.
May Improve Credit Score
Credit utilization on revolving debt, or credit cards, accounts for 30 percent of your credit score – the lower, the better. If you use a cash-out refinance to consolidate credit card debt, your utilization rate may plummet, and your credit score may likely increase.
Home Loans and Mortgage Refinancing
Disadvantages Of a Cash-Out Refinance
Unfortunately, there are also drawbacks of cash-out refinances to be aware of.
May Pay More Interest Long-Term
You’ll reset the loan term with a cash-out refinance. If you’ve held your current mortgage for many years, this could result in you paying more interest over the life of the loan as the lender will have more time to collect from you.
Closing Costs and Fees
On a cash-out refinance, you’ll pay closing costs, between 2 and 5 percent of the loan amount. Using the previous example, your closing costs will be between $7,200 and $18,000 since the new loan amount is $360,000.
Private Mortgage Insurance Cost
If the lender lets you borrow up to 90 percent of your home’s equity, you could be on the hook for private mortgage insurance. However, it will fall off once you reach 80 percent in equity in most instances.
Generally, you can write off any interest paid on your cash-out refinance loan if the funds are used to cover the costs of home improvements. However, you won’t have this perk if the funds are used for any other purpose.
Who Is Eligible for a Cash-Out Refinance?
Not all lenders are the same, so the qualification criteria could vary. However, here are some general eligibility criteria to keep in mind:
Most lenders require you to have at least 20 percent of equity built up in your home to qualify for a cash-out refinance.
You should have a credit score of at least 620 before you apply. However, a higher score means you’ll typically qualify for more competitive interest rates.
A reasonable debt-to-income (DTI) ratio that doesn’t exceed 50 percent is typically required. Some lenders could require borrowers to have a lower DTI, but the criteria could be more flexible if you have a higher credit score.
If you have a conventional loan, you must own the home for at least six months before applying for a cash-out refinance (unless it was inherited or awarded to you through the courts). The same rule applies to homeowners with VA loans, and the waiting period increases to 12 months for FHA loans.
Ultimately, there are many perks to cash-out refinances. You can pull cash out of your home, lower your payments and consolidate debt with a home refinance from LoanDepot.
Here’s how the process works:
- Step 1: Connect with a licensed lending officer on the LoanDepot team.
- Step 2: Establish your refinancing goals.
- Step 3: Select the most suitable cash-out refinance loan for you.
- Step 4: Complete a formal application.
- Step 5: Submit the documents required by underwriting to approve your loan.
- Step 6: Close on your cash-out refinance loan.
To date, LoanDepot has refinanced over $179 billion in mortgages and is available to help assist you with your cash-out refinance needs. Connect with a loan officer today online or at one of the 200 locations nationwide.