What Is a Cash Out Refinance and How Does It Work?

Learn What a Cash Out Refi Could Look Like for You

There are many different reasons why homeowners think about using their home's equity to access cash. For example, you may want extra funds for a renovation or you're interested in consolidating your debt with a lower fixed interest rate. With many different potential uses, a cash out refi could help you achieve your financial goals.

Keep reading to learn more about cash out refinances, how they work, eligibility requirements, and how to know when it might be the right time to apply for one.

What Are Cash Out Refinances?

A cash out refinance is a type of refinancing that turns your home's equity into cash by replacing your current mortgage with a new, bigger loan. You build home equity by making mortgage payments and when the value of your home increases.

Cash out refis can have lower rates than other types of loans (such as a home equity loan or a personal loan), making them a popular option for homeowners to borrow money. They also allow you to potentially lower your interest rate or get a fixed-rate mortgage to replace an adjustable-rate mortgage (ARM), which would mean a more predictable monthly payment.

You can use the funds from a cash out refinance to make home improvements, pay down other debts, or pay for major expenses. The money is yours to use how you want or need.

Cash Out Refinance Requirements

To qualify for a cash out refinance, you typically need to meet requirements such as:

• A substantial amount of equity in your home
• A loan-to-value ratio (LTV) of 80% or less
• A minimum credit score of 620
• A debt-to-income ratio (DTI), often no higher than 36%

Be sure to understand your lender's specific requirements to confirm your eligibility.

Types of Cash Out Refinances

Cash out refinancing with a Conventional loan is just one way to refinance your home loan and get funds to use as you need. There are other types of cash out refinances that have more flexible eligibility requirements, including:

• FHA cash out refinance: FHA cash out refis, insured by the Federal Housing Administration (FHA), often allow the homeowner to have a lower credit score and higher DTI than Conventional loans.
• VA cash out refinance: For eligible veterans, active-duty service members, and surviving spouses, VA cash out refinance loans can have lower minimum credit scores and higher LTVs that might help you borrow more money.

If you're not sure which option makes the most sense, Freedom Mortgage can help you determine the best loan for you.

How Do Cash Out Refinances Work?

The process of getting a cash out refinance is similar to other mortgage applications:

1. Figure Out How Much Cash You Need

Whether you plan to use a cash out refinance to tackle home improvements, debt consolidation, or another financial goal, your first step is to decide how much money you want to take out. Keep in mind that conventional loans typically allow for an LTV of no more than 80% for cash out refis—meaning you can only borrow up to 80% of your home's value—minus what you still owe on your current mortgage. Calculate your LTV to see what a cash out refi would look like for you.

2. Find a Lender and Complete the Application

Compare trusted lenders to find the best loan product and terms for your financial situation and goals. At Freedom Mortgage, our goal is to support you throughout every step of the process, helping you qualify for an affordable loan for your needs.

When you apply for the cash out refinance, you'll fill out a mortgage application and provide documents like income statements, proof of employment, and tax returns.

3. Get a Home Appraisal

Cash out refinances usually require a home appraisal to verify the value of your home. Lenders use this information to determine how much money you qualify for and your new loan terms.

4. Close on the Loan and Pay Any Fees

After you've been approved, you'll sign the paperwork to close on your new loan. At closing, you'll pay any fees for services like appraisals, title searches, title insurance, real estate taxes, and loan origination charges. Often, you can choose whether to pay these fees upfront or have them rolled into the new loan amount. You'll receive your cash out payment shortly after closing.

Cash Out Refinance Example

The amount of cash you can get depends on the value of your home's equity and the maximum LTV requirements for the loan. You usually can't borrow the full value of your home equity. Instead, you can only borrow a portion of it. Here's an example:

Home value: $350,000
Current mortgage balance: $200,000
Sample maximum LTV: 0.8 or 80%
Maximum new mortgage balance: $280,000 ($350,000 x 0.8)
Maximum cash available: $80,000 ($280,000 - $200,000)

In this example, we've used an 80% loan-to-value ratio because that is the typical maximum LTV for conventional and FHA cash out refinances.

This means the new mortgage balance can be no more than 80% of the value of your home or $280,000. Because the homeowner in this example has a large amount of equity, they may be able to get up to $80,000 in cash by refinancing.

Cash Out Refinance Key Considerations

It's always best to weigh potential pros and cons before making a big financial decision, like pursuing a cash out refinance. Potential benefits of cash out refinances include:

• Competitive interest rates that can be lower than other types of loans
• Access to a large sum of money
• Flexible options for using the funds
• A possible increase in home value if you use the money to pay for home renovations

You should also keep these potential drawbacks of cash out refis in mind:

• A potentially longer repayment period (because you now have a larger loan with a repayment term that's just starting)
• A likely increase in the size of your monthly mortgage payment
• Since your home is collateral for the mortgage, the risk of foreclosure if you fail to make regular monthly payments
• The expense of closing costs and fees

Cash Out Refis vs. Home Equity Loans vs. HELOCs

Cash out refinances, home equity loans, and home equity lines of credit (HELOCs) all let you tap into your home's equity, but they function differently.

With a cash out refinance, you refinance your current mortgage and pocket the difference in cash. A home equity loan is a second mortgage taken out against your equity, which means having two monthly payments. A HELOC is also a second mortgage, but it works more like a credit card, and you draw from the line of credit as needed.

You should consider factors like interest rates, repayment terms, and fees for each option before deciding which is best for you.

Cash Out Refinance FAQs

Here are some answers to common questions homeowners have about cash out refinances.

How Much Does a Cash Out Refi Cost?

The cost of a cash out refinance depends on how much you have to pay in closing costs. You can often expect to pay between 2% and 6% of the loan amount in closing costs. For example, if you refinance to a $300,000 loan, you could pay between $6,000 and $18,000 in closing costs.

How Long Does a Cash Out Refinance Take?

It typically takes less than 45 days to close on a conventional cash out refinance loan. That length of time could vary, however, depending on many factors.

Is a Cash Out Refinance a Good Idea?

If you've built enough equity in your home, you have a clear plan for how you'll use the funds, and you're confident you can afford your new mortgage payment, a cash out refinance may be the right choice. Again, if you're not sure, Freedom Mortgage will help you figure it out.

How Much Money Can I Get with a Cash Out Refi?

How much cash you can get from a cash out refi depends on your home's appraised value and how much of that value you're allowed to borrow. Typically, you can have an LTV ratio as high as 80%, but you may not need to borrow the full amount you can access. Plan what you're using the money for, determine how much you need, and only borrow that much. This could help ensure you maintain a mortgage payment that's manageable for your budget.

Final Thoughts: Cash Out Refinances

Whether you plan to fund a big home improvement project, pay off a personal loan, or invest in your future, a cash out refinance can help make dreams a reality. If you're interested in the benefits of a conventional cash out refinance loan, or want expert advice on any mortgage option, start the process by getting prequalified today or speaking with a loan advisor.