A cash out refinance is a way of borrowing money against your home’s equity. You replace your current mortgage with a new mortgage for a higher amount and get cash at closing. For example, if you have a $150,000 mortgage and substantial home equity, you might refinance to a $200,000 mortgage and get $50,000 in cash.
How does a cash out refinance work?
You need equity in your home to qualify for a cash out refinance. The amount of home equity you need depends on the maximum loan-to-value ratio (LTV) of the refinance. LTV helps determine whether you qualify for a cash out refinance as well as how much cash you may be able to get. Look at this sample calculation:
|Current mortgage balance||$125,000|
|Sample maximum LTV||0.8 or "80%"|
|Maximum new mortgage balance||$220,000 ($275,000 x 0.8)|
|Maximum cash available||$95,000 ($220,000 - $125,00)|
In this example, the maximum LTV is 80%. That means the new mortgage balance can be no more than 80% of the value of the home which in this case is $220,000. Because the homeowner in this example has a large amount of home equity, they may be able to refinance and get up to $95,000 in cash.
Many types of cash out refinances, including FHA cash out refinances, often have a maximum LTV of 80%. VA loans can have a higher LTV. With a VA cash out refinance, you may qualify for a maximum LTV of 90% which can help you borrow more money.
Regardless of loan type, you will need to complete a new application and provide credit, income, and financial documents to get a cash out refinance. You will often need a new home appraisal to estimate the current value of your home. You will likely pay closing costs. And you will need to review and sign loan disclosures and attend the closing of your new mortgage.
Do you have to pay taxes on the cash?
Since the money from a cash out refinance is a loan, you do not have to pay income taxes on it. Getting a cash out refinance may benefit your tax deductions at the end of the year. Consult a tax advisor about the deductibility of mortgage interest.
When is it a good idea to consider cash out refinancing?
Homeowners get cash out refinances to pay for home improvements, educational expenses, or debt consolidation. You may be able to lower your interest rate too, depending on current rates.
Cash out refinances increase the amount of money you owe. Your monthly payments may increase. It may take longer to pay off your mortgage and you may pay more interest over the life of the loan too. Look at the benefits and costs and decide if cash out refinancing is right for you!