A cash-out refinance usually refers to a new, bigger mortgage that pays off your existing mortgage and gives you the difference in cash to spend or save as you please. By comparison, the more traditional option — a rate-and-term refinance — replaces your existing mortgage with a mortgage that’s roughly the same size and gives you limited or no cash back.
But when you don’t have an existing mortgage, a cash-out refinance is just a new first mortgage that lets you borrow a lot of money against your home.
Can I get a cash-out refinance on a paid-off home?
Yes, it’s possible to get a cash-out refinance on a paid-off home. It’s still called a refinance even though you won’t be paying off an existing mortgage. Maybe you’ve even inherited a home that you’ve never borrowed against. The loan will still be called a cash-out refinance (unless it’s a home equity loan, which we’ll get to in a minute).
Whatever your reasons are for getting a cash-out refinance on a paid-off home, these are the requirements you’ll need to meet:
- Debt-to-income (DTI) ratio: DTI compares your existing monthly debt payments plus your proposed mortgage payment to your gross monthly income. A DTI of 36% or less will increase your chance of approval. Some lenders may allow you to have a DTI as high as 50%. If your DTI is 45% or higher, your lender may require you to hold six months of cash reserves.
- Credit score: You’ll need a credit score of at least 640 to qualify for a cash-out refinance. The more equity you’re cashing out and the higher your DTI, the better your credit score will need to be. For example, if you want to cash out more than 75% of your equity and your DTI is 45%, you’ll need a credit score of 700 under Fannie Mae's requirements.
- Property taxes: Your lender may require that you’re up to date on your property tax obligations to qualify for a cash-out refinance. If you’re behind, then you’re at risk of losing your home to tax foreclosure. In some cases, you may be able to use the cash-out refinance to pay off your delinquent property taxes.
- Insurance: You’ll need adequate homeowners insurance to qualify for a cash-out refinance. The insurance must provide replacement cost coverage for fires, windstorms, hurricanes, and other standard perils. If you live in an area where certain types of coverage are hard to come by (for example, an area affected by wildfires), it’s important to be aware of this requirement.
When can you not get a cash-out refinance on a paid-off home?
Even if you meet the above requirements, there are some instances where you may not be able to get a cash-out refinance on a paid-off home, such as:
- You want to cash out too much equity. When you do a cash-out refinance, lenders require you to retain a certain amount of equity in your home, often 20%, to reduce their risk. So if your home is worth $400,000 and you want to borrow $380,000 — which would leave you with just 5% equity — you likely won’t find a lender willing to close that deal.
- Your home is for sale. Under Fannie Mae guidelines, you won’t be able to close on a cash-out refinance loan if your home is listed for sale.
- You bought the home less than six months ago. With limited exceptions, Fannie Mae won’t allow a cash-out refinance on a home where at least one borrower hasn’t owned the home for at least six months.
You should always compare rates with multiple lenders before you decide to go with a cash-out refinance.
How much can I get from a cash-out refinance?
If your lender requires your loan-to-value (LTV) ratio to be 80% or lower, then you can cash out no more than 80% of your home’s value. This means that for every $100,000 your home is worth, you can borrow no more than $80,000.
Some lenders allow a higher LTV. If you qualify for a 90% LTV loan, for example, you could borrow up to $360,000 on a $400,000 property.
See: Using a Cash-Out Refinance to Buy a Second Home: A Good Idea?
HELOC vs. cash-out refinance
A home equity line of credit might be a better option than a cash-out refinance if you want to borrow smaller sums on an as-needed basis and you don’t mind paying a variable interest rate.
Many lenders offer HELOCs with no closing costs and only require you to pay interest during the draw period. Some also offer below-market introductory rates and will let you lock in a fixed rate on some or all of what you borrow.
Learn More: Refinancing for Home Improvements: Should You Do It?
Home equity loan vs. cash-out refinance
A home equity loan will function just like a cash-out refinance on a paid-off home as far as the cashback goes. You’ll be able to borrow a lump sum with a fixed interest rate for up to 30 years. A home equity loan that’s the only loan against your house — what lenders call “in first-lien position” — can have a similar interest rate to a cash-out refinance.
Also, closing costs on a home equity loan may be lower than those on a cash-out refinance, and you may be able to borrow against more of your equity with a home equity loan than a cash-out refi. It’s worth getting quotes for both types of loans from multiple lenders to find the best option.
See: Cash-Out Refinancing vs. Home Equity Loan: How to Choose
Things to consider before getting a cash-out refinance for a paid-off home
Taking out a new mortgage is a big decision. You’ll want to make that decision with these things in mind:
- Financial security: With a cash-out refinance or any other mortgage, you could lose your home if you can’t make your monthly payments. By comparison, credit card debt and most personal loans are unsecured. Your house is still an asset that creditors can go after if you default on an unsecured loan, but that process may take far longer than a mortgage foreclosure.
- Closing costs: Closing costs on a cash-out refinance typically range from 2% to 5% of the loan amount, or $2,000 to $5,000 for every $100,000 borrowed. Other borrowing options may be less expensive overall if they don’t have these fees, even if the interest rate is slightly higher. You’ll want to compare APRs when evaluating your options.
- Time: It usually takes several weeks to refinance a home loan because so many parties are involved: loan officers, appraisers, title companies, and so on. Federal law also requires a three-day waiting period where you’re free to cancel the loan. This is called the right of rescission. Once it passes, your lender is free to disburse your loan proceeds.
- Loss of control: When your home is paid off, you call most of the shots. When a lender has an interest in your home, it gets to decide what type of insurance you have to carry and how much. Lenders can also require you to use an escrow account to pay your property taxes and insurance, which puts them, not you, in charge of making those payments on time.
Is a cash-out refinance for a paid-off home right for me?
Cash-out refinancing can be a good option for many people, but it isn’t the best choice in every situation.
It may be a good option if:
- You’ve shopped around and determined it’s the least costly way to meet your goals.
- You’re OK with using your home as collateral.
- You can wait several weeks to get the money you want.
It may not be a good option if:
- You’ve shopped around and found a different type of loan that will meet your needs at a lower cost.
- You like owning your home free and clear and don’t want to use your home as collateral.
- You need money within days, not weeks.
The bottom line is the collateral. If you decide to get a cash-out refinance, remember to make the payments on your new mortgage loan on time.
