The Cash-Out Refinance: Is It Right for You?

Cash-out refinancing allows you to tap into your home equity for extra cash, and can offer additional benefits in the right circumstances. Explore how it works, what to consider, and whether it’s the best way for you to take advantage of the equity you’ve built.

One of the benefits of homeownership is having the opportunity to build up home equity, which, once sufficient in its percentage of your home’s value, can be used to access needed cash. While there are a few ways to get that money into your hands, a cash-out refinance is an attractive option for many.

What Is Cash-Out Refinancing?

A cash-out refinance allows you to convert a portion of the home equity you own in your home into cash. This is done by replacing your existing mortgage with a new one that has a higher principal balance than what you currently owe, along with fresh terms (such as the interest rate and repayment schedule). You then receive the difference between the original balance and the new one (minus any associated costs of the transaction) in cash at the closing of your new mortgage.

This can provide you with flexible solutions to your immediate financial needs and even savings opportunities, by using the funds to cover unplanned expenses and make home repairs, or reduce your monthly and long-term expenses by rolling any high-interest debt into your new mortgage.

Let’s Compare: A Standard Refinance vs. Cash-Out Refinance

Like a cash-out refinance, a standard refinance (sometimes referred to as a Rate and Term Refinance) also replaces the original mortgage along with new terms, such as the interest rate (and whether that rate will be fixed or adjustable), monthly payment and length of the loan. The difference in this case, however, is that aside from any associated closing costs you may want to roll into the loan, you do not increase the principal balance in order to obtain a substantial sum of cash at closing (although it should be noted that you can sometimes incidentally receive a small cash back amount of up to 2% of the loan amount on a Rate and Term Refinance).

Most opt for a standard refinance to take advantage of more favorable terms, such as a lower interest rate and monthly payment. And if you currently have a government-backed loan such as an FHA, VA or USDA mortgage, you will also have a streamline refinance option available, which can usually be done with no appraisal or income verification.

Unlike standard refinancing, a cash-out refinance can only be an option if you have a certain amount of available equity in the home to draw from. Your available equity is generally calculated by taking the home’s current market value and subtracting the entire balance owed on the property. How much equity you’ll need to have available can depend on the cash-out refinance loan program you qualify for. Depending on the length of your remaining term at the time of your cash-out refinance along with the current state of interest rates versus where rates were when you originally got your mortgage, your monthly payment could potentially go up or down.

Here are three common cash-out refinance options:

• Conventional cash-out: Homeowners who own enough equity in their property to have at least 20-25% remaining after the principal balance and cash is taken out may qualify for a conventional cash-out refinance option, enabling them to access a portion of their home’s value in cash.

• FHA cash-out: Homeowners who will have at least 20% equity remaining after a refinance can pull out cash for various financial needs using an FHA cash-out refinance option. Keep in mind, an FHA cash-out loan is not the same as an FHA Streamline, which does not allow you to take cash out. Unlike conventional loans and regardless of the equity owned, any FHA loan will require mortgage insurance. In exchange, homeowners typically have an easier time qualifying, despite any potential lack of stellar credit history.

• VA cash-out: Veterans and active military members can take advantage of a VA Cash-Out Refinance, which typically allows access to a greater amount of home equity compared to other options (often 100% of the home’s value).

You do not have to have a current mortgage to obtain a cash-out refinance on your home, and as long as you meet the eligibility requirements, you can refinance from any loan type to another (such as, from an ARM to a conventional fixed-rate home loan or an FHA loan to a conventional mortgage).

How Does a Cash-Out Refinance Work?

As with your original mortgage, obtaining a cash-out refinance involves the following steps:

1. Understanding and Meeting Lender’s Qualifications: Qualification criteria for a cash-out refinance can vary by lender, but each lender will evaluate, at a minimum, your credit score, debt and the amount of equity you have.

2. Establishing How Much You Want to Borrow: When doing a cash-out refinance, estimating how much cash you truly need is important. You want to avoid overborrowing and ending up with higher monthly payments that strain your budget. You also don't want to underestimate how much you need to cover your financial goals, leaving you to seek additional funding later on.

3. Starting the Process: As with your original mortgage, you’ll need to work with a lender, complete an application, provide documentation and undergo the underwriting process. Your lender will guide you through everything. Once you’ve received final approval, you’ll close on the loan and receive your cash-out funds.

Benefits of a Cash-Out Refinance

There are numerous benefits to obtaining a cash-out refinance. The following are common advantages homeowners enjoy by turning some of their home equity into accessible funds:

Lower Your Monthly Bills

A cash-out refinance could put money back into your pocket every month. Let’s say you currently pay $2,000 a month on your mortgage, $500 on a car and $600 on a truck. If you can pay off your vehicles with equity from your home, you could save $1,100 per month in auto payments and potentially reduce overall interest.

Consolidate Credit Card Debt

If you have substantial high-interest credit card debt, you can use your funds from a cash-out refinance to pay off those debts. This consolidates your credit card balances into your mortgage, replacing multiple payments with a single monthly mortgage payment.

This may simplify your finances, help you get a handle on your debt and potentially reduce the amount of interest you have to pay since mortgage rates are typically lower than credit card rates. Plus, with credit cards paid down or paid off in full, your credit utilization goes down, which could also have a positive impact on your credit.

Another option to consider in the case of debt consolidation would be to take the money you were initially paying toward the high-interest credit cards (or any other debt you pay off with the refinance) and put it towards your mortgage payment, paying down your loan significantly faster and saving even more interest over the life of your loan.

Add Value to Your Home

If you’re thinking about remodeling, a cash-out refinance can provide the funding to put your plan into action. It allows you to take the equity you’ve built in your home and reinvest it with a renovation, which may help increase the resale value of your home long term. This use for a cash-out refinance may also qualify you for a tax deduction for the interest you end up paying. Be sure to check with your tax advisor for further information.

Be Financially Prepared for Emergencies

The money from a cash-out refinance can be used to build a financial cushion to cover unexpected expenses.

Pay Tuition or Other Large Expenses

A cash-out refinance is a common strategy for paying college tuition, medical bills or other major purchases.

Invest in Your Future

Some homeowners use the money to fund ventures, such as purchasing an investment property or starting a business.

What Could a Cash-Out Refinance Look Like for You?

Let’s take a look at an example cash-out refinance scenario for a homeowner we’ve named Susan. Susan is considering a cash-out refinance to consolidate her debt and lower her monthly expenses. The current appraised value of her home is $400,000, and the existing balance on her mortgage is $250,000. In addition to her mortgage, Susan also owes:

• $32,000 on a credit card at an interest rate of 18%
• $14,000 for a 60-month auto loan at an interest rate of 7%

Susan has a minimum payment of $640.00 a month on her credit card and $277.22 per month on her auto loan. Here’s what a cash-out refinance could look like for her:

	Before: Current Mortgage + Other Debts	After: Cash-Out Refinance
Monthly Mortgage Payment	$1,580.01**	$1,870.73**
Loan Balance	$250,000	$296,000
Loan Term	30-year	30-year
Mortgage Interest Rate	6.499%	6.499%
APR	6.769%	6.889%
Credit Card Monthly Payment	$640.00	N/A
Credit Card Interest	18.00%	N/A
Monthly Car Payment	$277.22	N/A
Auto Loan Interest Rate	7.00%	N/A
Total Monthly Payments	$2,497.22	$1870.73
Total Monthly Savings	N/A	$626.50

^**Principal and interest only. Excludes taxes and insurance. New loan assumes a conventional loan, 760 FICO. Example credit card minimum monthly payment is calculated at 2% of balance.

In this example, if Susan consolidates her debt with a conventional cash-out refinance, her new loan would be $296,000 (plus any associated closing costs that can be rolled into the loan) and she would have just one payment a month in place of the original three, along with an extra $626.50 in her pocket every month.

Your Cash-Out Refinance: What to Consider

When used responsibly, cash-out refinancing can be a great option to leverage home equity. However, it's important to consider all the factors when deciding if it suits your situation and goals.

Keep the following in mind:

It Is Not an ATM

Be certain it makes sense financially for you to increase your loan balance right now in exchange for the cash. Are market interest rates favorably lower than when you originated your mortgage? Will you be using it to lower your overall interest paid by consolidating high-interest debt? Maybe you plan on funding a much needed education or business venture to hopefully increase your future earnings. Or perhaps you will renovate or make home repairs that only add to the value of your home. All of these scenarios above can be smart reasons to opt for a cash-out refinance. If you're instead planning on using the cash to pay for an extravagant vacation or wedding, be sure you have a concrete reason to expect you’ll be able to make your new mortgage payment comfortably every month with room for emergencies.

Your Home Is the Collateral

As with any mortgage, your home is on the line for the loan as collateral. Be sure it’s realistic for you to commit to your new monthly payments. And preferably there would be a long-term financial benefit for taking on a new loan. If you use a cash-out refinance to remedy bad financial habits, you could find yourself in a heap of trouble.

New Loan With New Terms

Because a cash-out refinance is essentially taking out a new mortgage with a larger loan amount, it restarts the amortization process. This means you’ll pay interest for a longer period before a significant portion of your payments go toward reducing the principal balance.

With a cash-out refinance, you’ll have a new interest rate on the full balance — not just on the newly borrowed cash. If you extend your loan term or take out a larger loan amount, you may end up paying more total interest over the life of the loan, even if your new interest rate is lower.

Refinancing to a shorter term may help you avoid paying more interest over time. This can result in higher monthly payments, but you could benefit from a lower rate and less interest paid over the life of the loan. Also, you can ask your Pennymac Loan Expert about the flexible term options available on many Pennymac mortgage products. You may be able to keep a similar term to what you currently have (e.g., 24 or 27 years) in case you don’t want to restart at 30 years again when you refinance.

Ask About Mortgage Insurance

If you have a conventional loan and at least 20% equity in your home after the cash-out refinance, you may be able to eliminate mortgage insurance. If you obtain a new FHA loan to take cash out, however, you will still have to pay an upfront mortgage insurance premium as well as annual mortgage insurance. If you currently have an FHA loan and at least 20% available equity, you may find refinancing to a conventional loan more financially favorable, as it will eliminate the need for mortgage insurance altogether.

While some veterans are exempt from this, if you have a VA loan, you may be responsible for paying a one-time funding fee when doing a cash-out refinance. If you’re not sure of your own standing, your VA funding fee exemption status will typically be shown on your Certificate of Eligibility (COE).

Closing Fees and Costs

Similar to when you first purchased your home, you will have to pay closing costs and fees on a refinance. While you may have the option to roll your closing costs into your loan amount, you should still do the math and determine if the benefits will outweigh the costs.

Take a close look at costs and weigh them against how you plan to use the funds and the amount you want to take out. Ordinarily, borrowers refinance to obtain better loan terms — a lower interest rate, a shorter term or a predictable monthly payment — such as when one switches from an adjustable rate mortgage (ARM) to a fixed-rate loan.

Is Cash-Out Refinancing Right for You?

Only you can decide what financing is best for you. In some situations, taking cash out of your home equity is smart or even necessary, but you should consider your decision carefully. If you don't really need the money, it probably makes more sense to go the route of a rate and term refinance or even no refinance, until the need should legitimately arise.

If you’d like help figuring out what works best for you, connect with a Pennymac Loan Officer or apply online to get started. Let our pros guide you through your options and help you find the best solution for your financial needs and long-term goals.

FAQs

How much money can I take out with cash-out refinancing?

Borrowing maximums vary by lender, but the amount generally depends on your home value. Many lenders have an 80% limit, meaning that after the cash-out refinance, the total amount of your new mortgage cannot exceed 80% of your home’s current appraised value.

Does a cash-out refinance affect my monthly mortgage payment?

Yes, in most cases it will. A cash-out refinance raises your loan amount, which can lead to higher monthly payments. However, if you refinance to a longer loan term, for example, from a 15-year mortgage to a 30-year mortgage, your monthly principal payment could decrease — but the total interest you pay could increase over your loan term. The exact monthly payment change would depend on the new interest rate, the term and the amount of cash taken out.

How long does a cash-out refinance take?

The underwriting of a cash-out refinance typically takes 30 to 45 days to close. The timeframe can vary based on factors such as the loan type, financial complexity, the lender and the volume of applications. To help streamline the process, try to gather key documents like tax returns and income verification as soon as you decide on a loan type.

Are there penalties for paying off the loan early?

Prepayment penalties vary by lender. Pennymac does not have any prepayment penalties.

Cash-out refinance vs. HELOC

While both cash-out refinances and home equity lines of credit (HELOCs) allow you to obtain funds from your home equity, they differ in many ways. A HELOC functions as a second mortgage, allowing homeowners to withdraw and repay funds from a revolving credit line as needed. Your primary mortgage remains the same.

Most HELOCs have a variable interest rate, meaning the rate fluctuates based on the prime rate. This is a notable difference between HELOCs and cash-out refinances since the ability to lock in a fixed rate is one of the popular reasons homeowners opt to refinance. And unlike home equity loans or cash-out refinancing, HELOCs would not be an advisable choice for someone who wants to consolidate high-interest debt to save and lower their monthly financial obligations.

Cash-out refinance vs. home equity loan

A cash-out refinance replaces your current primary mortgage with a new one that has a larger loan amount. You will have one mortgage with a new rate and term and a single monthly mortgage payment.

Like a HELOC, a home equity loan is a second mortgage added to your home independent of your current primary mortgage. Your existing mortgage remains the same, but you now have two loans — and two liens against your home — instead of one. But unlike a HELOC, you will have one low fixed rate and payment set for the entire life of the repayment schedule.

And just like cash-out refinancing, both second mortgage options could allow a homeowner to obtain a tax deduction, should the funds be used in a qualifying manner, such as for home renovation.*

Home equity loans typically have lower closing costs compared to cash-out refinances, which can be appealing if you need a lump sum for a specific expense. However, if you can lock in a lower interest rate through a cash-out refinance and plan to remain in your home for an extended period, it could be the better choice. Whichever option you choose, ensure your budget can comfortably manage the increased loan amount.

By refinancing your existing loan, your total finance charges may be higher over the life of the loan.

^*Consult a tax adviser for further information regarding the deductibility of interest and charges.