Cash Out Refinancing: How-to Guide
If you’ve been paying off your mortgage and building equity in your home, you’ve invested in a great asset. But what do you do when you need access to that equity to meet financial goals?
While the lower interest rate and (fairly) easy access to cash can make cash out refinance seem like an ideal option, it’s important to know exactly how to do a cash out refinance before you start the process. In this guide, we’ll explain how to do a cash out refinance from A to Z.
As you read through each step of the process, consider the pros and cons to make the best decision for your long-term financial health. You may even find that cash out refinance isn’t the best option for you after all and that a home equity loan alternative might be better.
Step 1: Understand the Fine Print of a Cash Out Refinance
Simply put, a cash out refinance allows you to pay off your current mortgage with a new home loan that is worth more than the remainder of your mortgage.
Say you had a mortgage rate for $300,000, and you’ve paid off $100,000 of the principal. You still have $200,000 to pay to own your house fully. If you choose to refinance and cash out, you might get a new loan for $240,000.
- $200,000 would go toward paying off your original mortgage.
- $40,000 would be your “cash out:” After closing, you would get a check for $40,000.
- You would also have new loan terms on your ‘new’ mortgage: you might have a lower interest rate or different monthly payment than you did before.
Keep in mind that refinancing isn’t free. To take out a new loan, you’ll need to pay various closing costs and fees. On average, these total to around $4,000, but your specific closing costs will be determined by your loan amount, credit history, geographic location, and other factors.
If you don’t have enough cash on hand to pay for your closing costs, you can roll them into your loan. Keep in mind that this will result in an even higher loan term, and you’ll be paying interest on that higher total sum for the rest of your existing mortgage term.
Step 2: Decide on Your Goals for Refinancing
Though it may seem appealing to receive a large check that you can use freely, you’ll want to consider exactly what you will use the cash-out amount for before you start the process.
Not all purchases are financially savvy to make with funds you’ve collected against your home equity.
Good Reasons to Refinance and Cash Out
You’ll be paying interest on your larger loan. So the best way to spend the cash you’ve taken out helps rebuild your home’s equity or wealth in the long term.
A refinance can make sense when your goal is financing:
- Home repairs – Hoping to do a cash out refinance for home improvements? If you intend to put the funds toward a home renovation or repair, that will increase your home’s value.
- Consolidating debt – If you have considerable credit card debt, you may be able to pay it off at a lower interest rate with debt consolidation refinance. It’s important to prevent any further high-interest credit card debt once you’ve consolidated, though.
Poor Reasons to Refinance and Cash Out
In contrast, some expenditures could put you in a worse financial situation than when you started.
- Getting a lower interest rate – If you purchased your home with an interest rate above 8%, you can likely get a new home loan at a lower interest rate. This is a good reason to refinance in general, but not a good reason to take out a larger loan and dilute your equity.
- Paying for things that are not assets – If you’re looking to use the money from your refinance loan for a car or a vacation, you might consider another option. Your home’s equity is an investment that could make you money down the line, so you won’t improve your financial situation by spending it on inessential purchases that are not investments. One option that would be better is doing a cash out refinance to buy a second home.
How Much Cash Do You Need?
Cash out refinancing limits the amount you can borrow against the equity you have accrued. So if you had paid off $100,000 on the principal amount of your mortgage, you could only “cash out” up to $80k or $90k.1
Come up with a range that you’d like to be able to cash out from your cash out refinance. You may or may not be able to get a loan for the entire amount, but you will need to tell your lender the amount you’d like to qualify for.
Step 3: Do the Work to Understand Your Financial Situation
Once you know how you’ll use the cash from your cash out refinance loan, it’s time to assess the health of your finances. There are two things you’ll need to focus on:
- Your credit score – As with any loan, the size and interest rate of the loan you can get will depend on your credit score.
- Your mortgage – How much of your mortgage have you paid off? If you have only had your house for a few years, you may have paid more on your mortgage interest than you’ve paid on the principal. Your equity is equal to the amount you’ve paid on the principal of your mortgage. The more equity you have, the more you can cash out in a cash out refinance.
Step 4: Take the Time You Need to Shop with Lenders
Once you’re ready to refinance, the next step is to shop around and find the best interest rates for the amount that you qualify for.
The interest rate for your new loan must be the same or less than the interest rate on your current mortgage. Otherwise, it isn’t worth refinancing your home.
Be aware that even if your interest rate is lower, you may still have higher monthly payments on your new mortgage. The amount that you will cash out will be distributed into your payments (plus interest) and will affect your monthly payment amount.
Step 5: Choose Your Lender and Loan
In this step, you’ll let your preferred lender know that you’d like to move forward on their best offer. You’ll apply for the loan, and your lender will process it for you.
During this stage, your lender will commission a home appraisal. A qualified professional will assess the fair market value of your home, and the bank will use that assessment to decide how much they can loan you.
- You will usually be responsible for paying the appraisal fee—usually around $500.
- And major flaws or needed repairs could depreciate the value of your home.
- If the appraiser finds the home’s value is less than the amount of your prospective loan, the refinance could fall through.
If the appraised value is less than you anticipated, you may find this is not the right time to refinance. And losing $500 or so is less costly in the long term than taking out a loan that does not meet your financial needs.
If all goes well at the appraisal, it can take anywhere from 1 month to six weeks for your lender to process a refinancing loan. If there are complications with your loan, it can take up to two months.
Step 6: Close on Your Loan and Receive Your Check
After the 30-60 days it takes to process your loan, you’ll be able to close on your equity cash out refinance. You’ll have new monthly mortgage payments and the cash from your “cash out.”
Alternative Ways to Convert Your Equity to Cash
The more you know about how to do a cash out refinance and consider these steps before you start, the better financial decisions you will be able to make.
Cash out refinancing isn’t the only way to convert your equity into cash, though.
Other options include:
- Home Equity Line of Credit (HELOC) – A combination of a credit card and a home equity loan, a HELOC loan gives you a line of credit based on your home equity. You can use this credit to pay for your expenses. A HELOC provides flexibility since you’re only paying back the amount you spend. However, keep in mind that your HELOC spending will increase your total debt. Likewise, it functions as a second mortgage on your home.
- Selling your home – Ready to access all your equity? Selling your home can free up capital to spend on your next big dream. Just keep in mind that selling a home can sometimes be expensive between the cost of repairs, staging, and paying your realtor. If your goal is minimizing speed and maximizing profit, look for a cash buyer who will buy your home as-is.
Sale-Leaseback Solutions: A New Way To Maximize Home Equity
If you’re ready to convert your equity into cash without taking on more debt, consider a sale-leaseback program.
Whether your goal is to stay in your home for the long term, finance repairs before selling, or start searching for your next dream location within weeks a sale-leaseback solution may make your living situation and your finances more supportive of your needs.
Whether you’re mulling over the financial plan for your retirement or considering options to consolidate your debt, you’ve probably come across reverse mortgages during your research. We have alternative options for reverse mortgages. If you are still unsure of alternative options to reverse mortgages, after reading this article, consult a financial advisor to discuss your options.
- Value Penguin. Average cost of a refinance. https://www.valuepenguin.com/mortgages/average-cost-of-refinance
- Nerdwallet.com. Cash Out Refinance Pros and Cons. https://www.nerdwallet.com/article/mortgages/refinance-cash-out
- Nasdaq.com. 3 Reasons I Won’t Do a Cash Out Refinance. https://www.nasdaq.com/articles/3-reasons-i-wont-do-a-cash-out-refinance-2021-06-16