A cash-out refinance is a smart way to leverage the equity you’ve built in your home. Through this type of refinancing, you take out a new loan for more than your current mortgage balance and pocket the difference as cash. You can use the funds for virtually any purpose — from consolidating debt to funding home improvements or covering a big-ticket purchase.
What is cash-out refinancing?
A cash-out refinance is a new mortgage that’s larger than your existing mortgage. You’ll use the funds to pay off your existing mortgage and receive the remaining funds as cash. This new mortgage may come with a new monthly payment, repayment term, and interest rate.
Here’s how it works: Say your home is worth $300,000. You currently owe $250,000 on your mortgage and you want to pay off $15,000 in credit card debt. With a cash-out refinance, your new mortgage balance would be $265,000: Your existing $250,000 balance plus the $15,000 you need to pay down debt.
You’ll replace your old mortgage with $250,000 from your cash-out refinance. After closing, your lender will deposit the remaining $15,000 into your bank account.
What are the pros of cash-out refinancing?
Tapping into your home equity with a cash-out refinance has many advantages. Consider the following:
- Access to cash: The main advantage of cash-out refinancing is tapping into your home equity for a lump sum of cash. Lenders will typically let you borrow up to 80% of your home’s value. This means that if your home is worth $300,000, you could borrow up to $240,000. You can use the funds from a cash-out refi however you please. Popular uses include making home improvements, paying off student loan debt, and funding large purchases.
- Tax benefits: Because the money you receive from a cash-out refinance is considered a loan rather than income, you don’t need to pay taxes on the funds you receive. If you use the cash for improvement projects that boost the value of your home, you may even be eligible for tax deductions.
- Lower interest rate: By refinancing your mortgage, you may be able to lock in a lower interest rate than you’re currently paying. Alex Capozzolo, real estate investor and founder of SD House Guys says: “Cash-out refinances typically offer some of the lowest interest rates available. This low rate allows borrowers to pay off other debts sooner than they could with higher-interest loans.” A reduced interest rate can help minimize your total loan cost.
- Boost your home value: If you use a cash-out refinance to improve or renovate your home, you could boost its market value and further build your equity. Improvements such as roof replacements upgraded electrical systems, and kitchen or bathroom remodels can increase your home value by as much as 15%. For a $500,000 home, this translates to an additional $75,000 in value.
- Predictable payments: Cash-out refinances are typically fixed-rate mortgages, meaning your monthly loan payments won’t fluctuate over time. Compared to other means of tapping home equity, like home equity lines of credit (HELOCs), the predictable payments of cash-out refinances can offer you peace of mind.
What are the cons of cash-out refinancing?
While there are many benefits to cash-out refinancing, it’s also important to consider the drawbacks.
- Lengthy processing window: A cash-out refinancing can take anywhere from 45 to 60 days to close. If you need money quickly, this type of loan may not be the best option. For fast access to funds, consider a personal loan or credit card. Though these forms of financing have higher interest rates than home loans, you can save on interest costs by paying them off quickly.
- High closing costs: Closing costs for home loans are typically 2% to 5% of the mortgage amount — which can quickly add up if you take out a large loan. Before applying for a cash-out refinance, ask lenders about fees and other additional charges so you know exactly how much your loan will cost.
- Increased risk of foreclosure: Because cash-out refinance replaces your current mortgage with a bigger one, your monthly payments may be higher if the loan term stays the same. If you fall behind on payments, you could lose your home.
- Waiting periods: You’ll typically have to wait a minimum of six months after the closing date of your current mortgage before you can apply for a cash-out refinance. If you need access to funds quickly, you’ll likely want to consider other options.
Keep Reading: The Pros and Cons of Cash-Out Refinancing
How can you use the money from cash-out refinancing?
One of the most obvious ways to use a cash-out refinance is to make repairs or improvements to your home.
But since you can use the money however you want, you could also consider using a cash-out refinance to pay for other major expenses — like getting out of debt or paying for higher education.
Paying off student loans
When it makes sense: You don’t qualify for an income-driven repayment plan, you can’t deduct student loan interest, or you want to extinguish your student loans fast.
Student loans often have single-digit interest rates, making them a relatively affordable type of debt — especially if you have federal loans and qualify for income-driven repayment.
But if you don’t qualify for payment plans or tax deductions that help make your loans more affordable (or you just want to get rid of them faster), you can turn your student debt into mortgage debt instead.
Look into Fannie Mae’s Student Loan Solutions program if you’re thinking about refinancing to pay off student loans.
Buying an investment property
When it makes sense: You have a large emergency fund and are willing to take on the responsibilities of owning two properties.
Managing and maintaining two properties can be time-consuming, expensive, and sometimes stressful. But there are good reasons to invest in real estate, like the potential for capital appreciation — especially on a fixer-upper in a desirable area — or the option to live in that property someday.
Covering emergency expenses
When it makes sense: You’re employed and you can wait at least 60 days to get the money.
The average time to process and close a cash-out refinance loan is around 45 to 60 days. But if you’re employed and can afford to wait up to two months to receive the funds, a cash-out refinance could be a viable strategy to cover emergency expenses.
Tip
Another option is to do a cash-out refinance and use the cash to create an emergency fund before you need it. The drawback is that you’ll be paying interest to have that emergency fund.
The upside is the money will be there the moment you need it, assuming you have the discipline not to spend it beforehand.
Funding renovations
When it makes sense: When postponing repairs could damage your home, or when upgrades will mean you can avoid moving.
Home renovations are costly. According to HomeAdvisor, the average cost of renovating a property is around $48,194 — with most projects falling between $17,715 and $78,881. If you need access to a big chunk of cash, borrowing against the equity in your home is a great way to fund home- renovation projects at a lower interest rate than personal loans and credit cards.
Another financially prudent use of a cash-out refinance: expanding your home to accommodate more people when you’re short on space and you’d rather not move.
