Cash out refinancing (in the case of real property) occurs when a loan is taken out on property already owned, and the loan amount is above and beyond the cost of transaction, payoff of existing liens, and related expenses.

Definition

Strictly speaking, all refinancing of debt is “cash-out,” when funds retrieved are utilized for anything other than repaying an existing lien. In the case of common usage of the term, cash-out refinancing refers to when equity is liquidated from a property above and beyond sum of the payoff of existing loans held in lien on the property, loan fees, costs associated with the loan, taxes, insurance, tax reserves, insurance reserves, and in the past any other non-lien debt held in the name of the owner being paid by loan proceeds.

Example of Cash-Out Refinancing

A homeowner who owes $80,000 on a home valued at $200,000 has $120,000 in equity. That equity can be liquidated with a cash-out refinance loan providing the loan is larger than $80,000.

The total amount of equity that can be withdrawn with a cash-out refinance is dependent on the mortgage lender, the cash-out refinance program, and other relative factors, such as the value of the home.

How does cash out refinance differ from a home equity loan?

• A home equity loan is a separate loan on top of your first mortgage.
• A cash-out refinance is a replacement of your first mortgage.
• The interest rates on a cash-out refinancing are usually, but not always, lower than the interest rate on a home equity loan.
• You pay closing costs when you refinance your mortgage.
• Generally, you don’t pay closing costs for a home equity loan.
• Closing costs can amount to hundreds or thousands of dollars.
• It probably does not make sense to refinance a higher amount at a higher rate. If your current mortgage is at a lower interest rate than you could get now by refinancing, it’s probably better to get a home equity loan. Alternatively, if you’re 20 years into a 30-year mortgage, you are paying more principal than interest with each mortgage payment and may not want to restart another 30-year mortgage.

Cash-Out Refinance Right for You?

If you’re interested in borrowing against your home’s available equity to pay for other expenses, you have choices. One option would be to refinance and get cash out, called cash-out refinance. Another option would be to take out a home equity loan or line of credit

Home equity loan or line of credit is usually taken out in addition to your existing first mortgage; rather than replacing it, it will have its own term and repayment schedule, separate from your first mortgage, and is considered a second mortgage. However, if your house is completely paid for and you have no mortgage, some lenders allow you to open a home equity line of credit in first lien position, meaning the home equity line will be your first mortgage.

You receive a lump sum when you close your refinance. The loan proceeds are first used to pay off your existing mortgage(s), including closing costs and prepaid, and any remaining funds are yours to use.

Cash-out refinance can typically offer a lower interest rate than a home equity loan. A Cash–out refinance is available on both a fixed rate and an adjustable rate mortgage. Your lender can provide information about fixed rate and adjustable rate mortgage options so you can decide which best fit your situation.

If you think that borrowing from your available home equity could be a good financial option for you, talk with your lender about cash-out refinancing, home equity loans, and home equity lines of credit. Based on your personal situation and financial needs, your lender can provide the information you need to help you choose the best option for your situation.

Should You Do a Cash-Out Refinance?

A cash-out refinance is a refinancing of an existing mortgage loan, where the new mortgage loan is for a larger amount than the existing mortgage loan, and you (the borrower) get the difference between the two loans in cash. Homeowners do cash-out refinances so they can turn some of the equity they’ve built up in their home into cash.

Here’s an example to illustrate: Let’s say you own a $400,000 house and still owe $300,000 on the current mortgage. (This means you have built up $100,000 in equity). Now let’s say you want some extra cash to the tune of $30,000. You could do a cash-out refinance to get this money. If you did this, you’d get a new loan worth a total of $330,000 (the $300,000 you still owe on your home, plus the $30,000 you’re going to take out in cash).

Before you do a cash-out refinance, here are some things you need to know:

Costs of Cash-out Refinance:

A cash-out refinance is similar to a regular refinancing of your mortgage in that you’re going to have to pay closing costs. These can add up to hundreds or even thousands of dollars. In addition, you’re going to have to pay interest on the cash that you get out (in addition, of course, to the mortgage amount), which can add up to thousands of dollars over the life of the loan.

How to use the cash:

Typically, you can use the cash you get from a cash-out refinance on pretty much anything you want, be it paying down your credit card debt or taking a vacation. In practice, however, some uses of the money are smarter than others. If you have high interest debt such as credit cards, it may make sense to use a cash-out refinance to pay off this debt, because the interest you pay for your credit card likely far exceeds the interest on your new mortgage loan. In doing this, you get other perks, too: You may boost your credit score by paying down your maxed-out credit cards, and you can get a tax benefit from moving the credit card debt to mortgage debt because you can deduct mortgage interest on your taxes. It may also make sense to use this money to do home improvements, which can boost your home’s value down the road. Just remember, no matter what you use the cash for, it’s risky: You could lose your house if you don’t repay the new mortgage loan amount.

Lenders Restrictions:

Many lenders won’t give borrowers in certain kinds of situations the option to do a cash-out refinance. Some common limits include: You may have to have a minimum credit score (often this is higher than with a regular refinance), have owned your home for at least a year and have a loan-to-value ratio (that’s the mortgage amount divided by the appraised value of the property) that’s a maximum of around 85 percent.

Explore Other Options:

Because of the costs associated with a cash-out refinance, you should also consider options such as a home equity loan (HEL) or a home equity line of credit (HELOC). Unlike a cash-out refinance, a home equity loan or line of credit is taken out separately from your existing mortgage. A home equity line of credit is a line of credit in which your home is the collateral; similar to a credit card, you can withdraw money from this line of credit whenever you need it up to a certain amount. The interest rate tends to be adjustable.

A home equity loan is a separate loan on top of your existing mortgage (again with your home as collateral), where you get the money you need in one lump sum (rather than withdrawing it when you need it as you do with a HELOC). Interest rates are fixed.

To pick which one is right for you, consider your needs: Do you want the money in a lump sum? If so, opt for a HEL or a cash-out refinance; if not, consider a HELOC. In addition, most importantly, do the all-in math: With closing costs, fees and total interest costs, which one will be the least expensive option for you? Note that interest rates are often lower on cash-out refinances than on home equity loans or lines of credit, but closing costs are often higher. Moreover, the cash-out refinance resets the term of your loan, so you may pay more in interest over the long haul.

Conclusion:

A cash-out refinance can be a good idea assuming you get a good interest rate, you know you can easily — and ideally quickly — pay back the new loan, and you need the cash for a worthwhile cause such as home improvements or paying down high-interest debt. Just be careful: If you don’t pay off this loan in full and on time, you can lose your home. On the other hand, you should not do a cash-out refinance if you’re not getting a better interest rate on the new loan, you want to spend the money on something such as a vacation or shopping spree and/or you’re worried about being able to pay back the new, larger loan.