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Every homeowner has their own reason for considering a cash-out refinance, but some popular ways to use your home equity as a financial tool include home repairs and renovations, refinancing higher-interest debt, and buying an investment property.
Here’s what you need to know if you’re contemplating a cash-out refinance:
- How cash-out refinancing works
- How much cash can you take out of your home?
- 7 ways to use your cash-out refinance
- Other ways to tap your home equity
How cash-out refinancing works
A cash-out refinance is a new mortgage that’s larger than your existing mortgage. You’ll pay off your existing mortgage, and the lender deposits the rest of the money into your bank account. You can use that money however you want.
Lenders have some flexibility in deciding who qualifies for a cash-out refinance. However, here’s what they’re typically looking for:
- A credit score of at least 620
- A debt-to-income ratio (DTI) no higher than 50%
- Enough home equity to still have 20% after cashing out
You can do a cash-out refinance with your existing lender, but you don’t have to. To get the best deal, you should shop around. Credible makes it easy to compare refinance rates from multiple lenders. Checking rates only takes a few minutes — it’s free and it won’t affect your credit score.
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How much cash can you take out of your home?
Lenders require you to have a minimum amount of home equity — what your home is worth minus what you owe on your mortgage — to qualify for a cash-out refinance.
Lenders usually allow you to borrow up to 80% of your home’s value for a conventional or FHA loan when you do a cash-out refinance. This means that if your home is worth $350,000, you could borrow up to $280,000.
If your current mortgage balance is $200,000, then you could get $80,000 from a cash-out refinance, minus closing costs.
For a cash-out refinance with a VA loan, you can borrow as much as 100% of your home’s value. The proceeds from a cash-out refinance are not taxable.
Learn More: Cash-Out Refinance Tax Implications
7 ways to use your cash-out refinance
One of the most obvious way 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.
Financing home improvement projects
Even the most conservative financial professional would probably approve of borrowing against your home when interest rates are low to make important home repairs.
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.
Paying off credit card debt
Financial experts caution against refinancing your mortgage to pay off high-interest debt, especially if you haven’t changed the circumstances or habits that got you into debt in the first place. And it’s a legitimate concern: You don’t want to end up in even more debt with your home acting as collateral.
But in many cases, paying off high-interest loans and credit cards with low-interest mortgage debt can provide the fresh start people need to get their finances back on track. It’s easier to make new, good habits work in your favor when you’re putting less of your monthly income toward interest.
Paying down student loans
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.
However, 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.
Paying for a child’s college education
The decision to pay for a child’s college education can be tricky. Experts often say it’s better for the student to borrow than for parents to put their retirement plans at risk.
Still, there may be circumstances when taking on low-interest mortgage debt so a child can attend college debt-free makes sense — for example, if your child has a strong work ethic that makes them likely to graduate and they’re willing to work to contribute toward their educational expenses.
Paying for investments
For most people, it’s probably not a good idea to reduce your home equity to take on the risk of investing in the stock market. However, it might make sense if the cash-out refinance terms are incredibly favorable, you have excellent credit, and you have a large emergency fund that covers six months or more of living expenses.
If a cash-out refinance to invest would improve your monthly cash flow and help you max out your contributions to tax-advantaged retirement accounts, the decision could pay off in the long run.
But if you want to use the money to gamble on cryptocurrency or another highly volatile asset, you’re probably better off keeping your equity in your home.
Learn more: Using a Cash-Out Refinance to Buy a Second Home: A Good Idea?
Buying an investment property
Managing and maintaining two properties can be time-consuming, expensive, and sometimes stressful. It’s a lot more work than owning an index fund, that’s for sure.
However, 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.
Check Out: Cash-Out Refinance on an Investment Property: How It Works
Covering emergency expenses
One situation where a cash-out refinance could be a good way to cover emergency expenses is if you become sick or disabled and you need cash to pay for treatment or help cover living expenses while you recover. If your household still has enough income to qualify for a cash-out refinance, this strategy might work.
Refinancing isn’t a fast way to get money, however. The average time to close a home loan was 53 days in April 2021, according to the latest Origination Insight Report from ICE Mortgage Technology.
The upside is the money will be there the moment you need it, assuming you have the discipline not to spend it.
Other ways to tap your home equity
These alternatives to accessing your home equity might be better for your circumstances than a cash-out refinance.
Home equity loan
The closing costs on a home equity loan should be substantially lower than the closing costs on a cash-out refinance. So if you want to borrow a lump sum at a fixed rate but you’re happy with your first mortgage, a home equity loan can be a better choice than a cash-out refinance.
Read More: Cash-Out Refinancing vs. Home Equity Loan: How to Choose
Home equity line of credit (HELOC)
A HELOC lets you borrow against your home’s equity as needed, up to your credit limit. If you’re doing a series of home projects over time, it can be a good way to borrow as you go and only pay interest on the money you need at the moment.
HELOCs also commonly gives you the option of making interest-only payments during the first several years, which can keep your monthly payments ultra-low.
Good to know: Unlike a home equity loan, this type of second mortgage has a variable interest rate that can go up or down. However, many lenders let you lock in a portion of what you’ve borrowed at a fixed rate.
Reverse mortgage
You must be at least 62 years old and have no mortgage or a small balance to qualify for a reverse mortgage. This type of loan can make sense if you want to age in place and your largest asset is your home. Reverse mortgages are a complex product with significant costs, but can be a good choice for some homeowners.
See: Reverse Mortgage Alternatives: 5 Options for Seniors
