Delayed Finance vs. Cash-Out Refinance: What’s the Difference?

Home equity helps you build wealth and can act as an emergency fund when unanticipated expenses arise. Most homeowners build equity gradually, over several years. But that’s not the only way to do it.

All-cash purchases result in 100% equity right from closing, but your money is tied up in the home. One way around that is to delay financing until after closing. Delayed financing lets buyers reap the benefits of a cash sale and then liquidate their equity almost immediately after they close.

However, delayed financing isn’t the only way to refinance your mortgage for extra money. A cash-out refinance is a means of replacing your existing mortgage with a new, larger mortgage. Your new loan pays off your old mortgage and you receive the remaining funds as cash.

What is delayed financing?

Delayed financing lets cash buyers get a mortgage with a cash-out refinance loan right after they’ve purchased a property. After refinancing your home, you receive a portion of the funds that you can use for virtually any purpose. Essentially, it’s a way to leverage equity from an all-cash sale to free up money for other expenses.

While a valuable tool for the right buyer, delayed financing is not a distinct type of financing. Rather, it’s an exception to the cash-out refinancing guidelines established by Fannie Mae and Freddie Mac that restrict the conditions under which you can refinance your home using a conventional loan.

Per Fannie Mae and Freddie Mac requirements, you typically have to wait six months after purchasing a home to do a cash-out refinance. But when you buy a home with upfront cash, there’s no waiting period to refinance your home.

How does delayed financing work?

First, you buy a home with cash. Shortly after the sale closes, you take out a cash-out refinance loan to borrow against your equity. The amount you can borrow is limited to your initial investment plus any closing costs you want to finance.

This strategy makes the most sense for investment-property buyers, who accounted for 16% of all-cash buyers in December 2022. It lets them maintain liquidity they can use to purchase additional properties. Primary-home and second-home buyers are also eligible for delayed financing, but closing costs and other expenses outweigh any potential benefits.

How to qualify for delayed financing

Fannie Mae and Freddie Mac have special eligibility criteria for delayed financing:

• The purchase was an arms-length transaction, meaning it occurred between unrelated people acting in their own self-interest. A sale between a parent and child or between close friends would not qualify, according to the Cornell Law School Legal Information Institute.
• The borrower must own the property.
• A title report must show there are no liens on the property.
• The settlement statement must verify that the home was purchased without mortgage financing.
• The source of the funds used to purchase the property must be documented. These documents can include bank statements or documents from a personal loan or home equity loan secured by another property.
• The borrower must meet eligibility requirements for the cash-out refinance loan.

What is a cash-out refinance?

A cash-out refinance is a new first mortgage that allows you to borrow additional money and take the difference in cash. Whereas a standard refinance loan only lets you borrow the amount needed to pay off your current loan.

The cash-out refinance must repay any existing mortgage in full. However, you can use the leftover cash for almost any reason, such as for home renovations or for a down payment on another home.

This could be a good option if the new loan will lower your interest rate, offer more favorable loan terms, or allow you to switch from an adjustable-rate to a fixed-rate mortgage.

How does a cash-out refinance work?

A cash-out refinance serves two purposes:

1. It replaces your current mortgage loan with a new one.
2. It gives you cash from the equity left over when the original loan has been repaid.

For example: Say you have $50,000 left on your mortgage, and you need $50,000 to renovate your home. Assuming you meet all the eligibility criteria, you could do a cash-out refinance for $100,000. The first $50,000 would repay your current mortgage. You’d receive the remaining $50,000 in cash.

How to qualify for a cash-out refinance

Different loan types have different qualification criteria, but here’s what Fannie Mae and Freddie Mac require for conventional loans:

• The original loan must be at least 12 months old.
• At least one borrower must have owned the home for a minimum of six months.
• Loan-to-value (LTV) ratio must be at least 75% for a one-unit investment property or second home and 80% for a one-unit primary residence.
• Maximum debt-to-income (DTI) ratio of 36% to 45%, depending on your credit score.
• Minimum credit score of 620, but requirements may vary depending on LTV, DTI, and other factors.

Keep Reading: Reasons for a Cash-Out Refinance: How to Use Your Home Equity

Pros and cons of delayed financing

Delayed financing makes sense for some buyers, but it’s not the best option for everyone. Consider the following benefits and drawbacks of delayed financing:

Pros

• Gives you a competitive edge: Buying with cash could help you negotiate a better deal or get your offer accepted. Sellers often prefer cash offers because they won’t have to worry about a borrower getting approved for a mortgage.
• Recover your cash: Financing after the fact frees up cash you can use for other expenses, such as making home improvements or buying a second home.
• No waiting period: When you use all cash to buy a home, you won’t have to wait six months to refinance and recoup your funds.

Cons

• Limited availability: Delayed financing can only be used for conventional loans, so this strategy isn’t an option for VA and FHA refinancing.
• Higher rates: Rates on mortgage refinance loans are typically higher than rates for purchase loans.

Pros and cons of a cash-out refinance

Regardless of when you do a cash-out refinance — whether it’s right after you close a cash sale or six months after purchasing a home with a mortgage — you’ll have benefits and drawbacks to consider as well.

Pros

• Access to cash for a variety of uses: Tapping into your home equity with a cash-out refinance grants you access to money that you can use however you please. Popular uses for cash-out refinance funds include debt consolidation, paying off student loans, or making home improvements.
• More favorable rates and terms: When you refinance your mortgage, you may be able to get a lower interest rate or a more favorable loan term.
• Tax benefits: Interest payments on a cash-out refinance are typically tax-deductible. The IRS doesn’t consider the money as income, but rather as another home loan. You’ll benefit from tax deductions if you use your cash-out refinance to make improvements that boost your home’s value.

Cons

• Closing costs: With a cash-out refi, you’ll pay closing costs similar to when you took out your original mortgage. These costs typically add up to about 2% to 5% of your loan amount and include charges such as attorney fees, appraisal fees, and loan underwriting fees.
• Reduced home equity: You’ll diminish your equity by the amount of the loan. This could put you at risk of going underwater on your mortgage, meaning your loan balance is more than your home is worth.
• Risk of foreclosure: Because this type of loan is secured with your home as collateral, you risk losing it if you can’t keep up with payments. Make sure to only borrow what you need and opt for a repayment term that allows you to comfortably fit your payments into your monthly budget.

Learn More: The Pros and Cons of Cash-Out Refinancing

Delayed financing vs. cash-out refinancing

It’s important to understand that your choice isn’t between delayed financing and cash-out refinancing. Delayed financing simply allows you to sidestep restrictions imposed on most cash-out refi borrowers. If you decide to take out a cash-out refinance loan in either case, it’s simply a matter of timing.

Your choice is either paying cash for your purchase now and refinancing right away (delayed financing) or financing your purchase now and refinancing later (cash-out refinance).

See: Cash-Out Refinancing on Paid-Off Home