• Cash-out refinancing offers qualified homeowners a chance to replace their current mortgage with a new loan under new terms while simultaneously converting some of their home equity into cash. 
  • If you can secure a lower interest rate under current conditions than the rate on your existing mortgage, you could potentially reduce your monthly payment and/or your overall interest expense even while increasing your loan amount.
  • If you cannot secure a lower interest rate under current conditions, a home equity loan or home equity line of credit (HELOC) may be a better path to tapping into home equity since neither alters your existing mortgage. 

A cash-out refinance can be a strategic way for homeowners to leverage home equity while refinancing their mortgage. Whether you're looking to consolidate debt, fund home improvements, pay other large expenses, or invest in new opportunities, this option allows you to leverage your property’s value for extra cash. 

It is important to weigh the pros and cons carefully because refinancing alters the terms of your existing home loan, which can change the interest rate, monthly payments, and long-term costs. 

In this guide, we’ll explain what cash-out refinancing is, how it works, and who is eligible. You’ll also learn the pros and cons and get information on alternatives like home equity loans and HELOCs. 

What Is a Cash-Out Refinance?

A cash-out refinance is when a homeowner replaces an existing mortgage with a new loan of a higher balance, receiving the difference in cash. The new loan pays off the existing mortgage and allows the borrower to pocket cash to be used as they see fit. 

For example, if a buyer owes $100,000 on their current mortgage and opts for a cash-out refi in the amount of $150,000, this $50,000 difference could be paid out as cash (minus any fees).

What Are Cash-Out Refi Funds Used For?

The funds from your cash-out refi can be used for a wide range of purposes, including:

How Does a Cash-Out Refinance Work?

With a cash-out refi, you take out a new, larger mortgage to pay off your existing mortgage and pocket the difference. 

Importantly, the new loan has its own mortgage interest rate and loan term. This is why refinancing is most advantageous when you can secure a lower rate in the current market than you have on your existing loan. By reducing the interest rate, you can potentially reduce your monthly payments and overall interest expense. 

Having said that, since the homeowner is increasing the amount borrowed, the monthly payments and interest rates could also increase because of the higher loan balance, even if the rate is lower. It is also possible to reduce the mortgage payments by increasing the loan term and spreading the balance across more payments, although this strategy may result in higher overall interest expense.    

Eligibility Requirements for a Cash-Out Refi

Not all homeowners qualify for a cash-out refinance. During the cash-out refi application, you will need to submit documentation supporting your financial qualifications. 

While exact eligibility criteria vary by lender, the following are common requirements for cash-out refi borrowers:

Sufficient Home Equity 

Many lenders require that you maintain a minimum amount of equity in your home after refinancing, such as 15 or 20%. This means you may be able to borrow 80-85% of your home's appraised value.

For example, imagine your home is worth $500,000 and you owe $225,000. The total equity would be $275,000. If a lender loans up to 80% of the home’s value, your new mortgage could be as much as $400,000 ($500,000 x .8). After paying off the $225,000 balance on the current mortgage, you could potentially cash out as much as $175,000 (minus closing costs).

Acceptable Credit Score

Credit scores are an important factor in deciding if you qualify for a cash-out refi and what the interest rate could be. While requirements vary by lender, many lenders look for credit scores of 620 or higher to qualify for a mortgage (perhaps accepting scores as low as 600 for select loan types), with the lowest interest rates reserved for borrowers with scores in the high 700s and up.[1]

Acceptable Debt-to-Income (DTI) Ratio

Lenders compare your total monthly debt payments to your monthly income, called a debt-to-income ratio, to make sure you can handle the new loan payments.[2] DTI requirements vary by lender, but it is common to see DTI minimums in the 35-43% range, meaning that no more than 35-43% of your pre-tax income is allocated to debt payments. 

Holding Period Minimums

Some lenders have waiting periods, which require homeowners to own the property for a set timeframe, perhaps six months or a year, before being eligible for a cash-out refi. 

Exceptions by Loan Type

Mortgage loan type can also factor into your ability to qualify for a cash-out refi. 

Government-backed mortgages (FHA loans, USDA loans, and FHA loans) may have different requirements than conventional loans. For example, VA loans may offer cash-out refinancing up to 90% of the home’s value for eligible veterans and military service members.[3]

Pros and Cons of a Cash-Out Refinance

The benefits of a cash-out refinance include:

  • Access to a lump sum of cash that can be spent or invested as you like.
  • Lower interest rates than many other loan types. One notable exception is a credit card with a 0% (or low to 0%) intro APR on balance transfers (or purchases and balance transfers).
  • If the money is used to repair or improve your home, the interest may be tax-deductible.[4] Discuss your options with a tax professional before making decisions based on tax implications.
  • The opportunity to replace a higher-interest mortgage with a lower-interest mortgage if you qualify for a lower rate under current conditions.
  • The option to restructure the terms of your primary mortgage to potentially lower the mortgage payments, freeing up money in your monthly budget for other expenses.

Potential disadvantages of a cash-out refinance include:

  • The possibility of foreclosure on your home if the loan is not repaid. This is true of all secured loans that use your home as collateral.
  • Loan origination fees and closing costs.
  • You could borrow more than needed, which may result in unnecessary interest expenses.
  • Increasing your debt balance may extend the time it takes to pay off your mortgage.
  • If interest rates have risen since the existing mortgage originated, refinancing could result in a higher interest rate on the entire mortgage amount, not just the cash-out portion.

Alternatives To Cash-Out Refinancing

If you want to cash out some of your home equity, but a cash-out refinance does not seem like the right fit, consider these alternatives.

Cash-Out Refinancing vs. Home Equity Loans

Like cash-out refis, home equity loans allow you to borrow against your home equity. Unlike cash-out refis, home equity loans do not affect your existing mortgage. A home equity loan is a second mortgage entirely separate from your primary mortgage. 

A home equity loan may be a good option if your current mortgage has a lower interest rate than you could secure under current conditions.  

Cash-Out Refinancing vs. HELOCs

Home equity lines of credit are similar to home equity loans in that they allow you to convert home equity into cash without altering your primary mortgage. 

Unlike cash-out refinancing and home equity loans, which both provide lump sums for the borrower, HELOCs open revolving lines of credit. This credit line can be used repeatedly (even if you take a large sum upfront), much like you would use a credit card. You can borrow against the line’s limit multiple times without incurring new origination fees. 

This can be a better fit than cash-out refinancing or home equity loans if you don’t know exactly how much money you may need. For example, if you are doing home renovations, a HELOC allows you to borrow as you go, preventing you from borrowing more or less than needed. 

However, if you are looking to replace the terms of your current primary mortgage while accessing some of your equity, a cash-out refi could still be the better option as it allows you to accomplish both objectives at the same time. 

Learn more about cash-out refinancing vs. HELOCs.

The Bottom Line

Cash-out refinancing can be a useful tool for accessing home equity while simultaneously replacing your current mortgage with a new loan under new terms. 

Depending on how the cash-out refi is structured, you could potentially lower your monthly mortgage payment, reduce your overall interest expense, or both. 

There are many factors to consider when applying for a cash-out refi, including the new interest rates available, how the change in loan duration will affect your payments and interest costs, fees incurred, and the amount you should borrow. When in doubt, contact a local mortgage loan officer to discuss your financial goals and options.