What is a Cash Out Refinance? (2024)

If you have a significant amount of equity built up in your home and would like to convert that equity into money in your pocket, a cash out refinance may make sense for you.

Cash out refinance: How it works

To qualify for a cash out refinance, you typically need to have a certain amount of equity in your home. The required amount will vary by lender. For example Discover ® Home Loans offers cash out refinancing up to a 90% combined loan-to-value (CLTV) ratio. For more information about CLTV, check out this resource:
When you apply for a cash out refinance, you’ll go through a similar process as a purchase mortgage application. This includes providing documentation to your lender about your income, credit history, and other personal financial information.
If your application is approved and there are no issues during processing, you’ll close on a new mortgage loan with a higher amount than your old one and potentially a new interest rate and term length.

Cash out refinance example

If your home is worth $300,000 and you owe $200,000, you have $100,000 in equity. With cash out refinancing, you could receive a portion of this equity in cash. If you wanted to take out $40,000 in cash, this amount would be added to the principal of your new home loan. In this example, the principal on your new mortgage after the cash out refinance would be $240,000.

Depending on your unique circ*mstances, a cash out refinance might make sense when you can lower the interest rate on your current mortgage or update your loan term so that your monthly payment works for your budget.

Consider this example: The current market value of your home is $300,000, and your mortgage balance is $200,000 with a 12% interest rate and a 30-year term. In this scenario, your monthly mortgage payments would be $2057.23.

If you wanted to do a cash out refinance and take out $40,000 from your home equity, your new loan amount would be $240,000. If you could get a new interest rate at 8.5% and selected a 30-year term again, your new monthly mortgage payment would be $1845.39.

Pros of a cash out refinance

Access to funds: A cash out refinance allows you to convert the increased equity in your home into cash. This provides you with a lump sum of money to pursue various goals such as home renovations, debt consolidation, or investment opportunities. It gives you the flexibility to use the cash as you see fit.
Potentially lower interest rate: If you originally obtained your mortgage when interest rates were high, refinancing at a lower rate could save you money in the long run. By consolidating your debts under one mortgage payment, you may effectively reduce your overall interest costs on outstanding debts.
Streamlined finances: Consolidating high-interest debts like credit cards or personal loans into your mortgage may simplify your financial life. Instead of managing multiple payment due dates and interest rates, you’ll have one monthly payment to keep track of. This might provide peace of mind and make budgeting easier.
Potential tax deductions: The interest paid on mortgage loans may be tax deductible. If you’re considering a cash out refinance, make sure you consult with a tax professional to understand the specific tax implications for your situation.

Cons of a cash out refinance

Increased debt: Cash out refinancing results in taking on a larger mortgage loan. This means your monthly payments can potentially increase as well. Before proceeding, ensure that your new payment can fit comfortably in your budget.
Closing costs: Just like when you initially obtained your mortgage, a cash out refinance may come with closing costs. These costs might include application fees, appraisal fees, origination fees, and more. It’s important to consider these expenses and determine if the long-term benefits outweigh the upfront costs. Some lenders may simplify this decision for you by offering no closing cost refinance options.
Risking your home: Your home serves as collateral for your mortgage. With a cash out refinance, you’re increasing your loan amount, which may lead to an increased risk of foreclosure if you’re unable to meet your mortgage obligations.
Resetting the loan term: If you’ve been repaying your mortgage for a significant amount of time already, you may have made progress towards the goal of owning your home outright. By refinancing, you’ll reset the loan term and potentially extend the time it takes to pay off your mortgage. This may result in paying more interest over the long term, so make sure to consider how a cash out refinance might help you achieve your goals before you apply.

The cash out refinance process

Once you accept the offer of the new mortgage, the funds from the cash out refinance will be disbursed. You can use the cash for pretty much anything you choose, but it’s important to remember that the new mortgage will likely have a higher monthly payment and potentially a longer repayment term than your previous mortgage.

The amount of time it takes to complete the process will vary by lender. If you choose to apply with Discover, the timeline breaks down like this:

Getting the basics (around 1-2 weeks). You’ll apply online or over the phone to review your loan options, then upload required documents. Discover will confirm your initial eligibility.
Processing your info (around 4 weeks). We gather third-party information about your home and send your complete application to underwriting for a final decision.
Closing your loan (around 1-2 weeks). We’ll contact you to schedule your loan closing and then arrange for funds to be sent to your accounts.

When is a cash out refinance a good option?

While you are free to use the cash in just about any way you want, a cash out refinance may be a good idea when you need to access your equity in your home to pay for large expenses such as home renovations, college tuition, medical bills, or elder care.

What are alternatives to a cash out refinance?

If a cash out refinance doesn’t sound like the right type of loan for you, there are other options for borrowing money from the equity in your home.

One important thing to note is that interest rates on any second mortgage will likely be higher than the interest rates you may qualify for with a cash out refinance. It’s common for single or first mortgages to be available with lower interest rate offers from lenders.

LEARN MORE: Cash out refinance vs Home equity loan

Home equity line of credit (HELOC)

A home equity line of credit (HELOC) more closely resembles revolving debt like a credit card. Unlike a home equity loan that provides you with a lump sum when you are approved, a HELOC extends a line of credit from which you can withdraw funds as you need them.

Any interest in the HELOC is based on the amount you withdraw, which can make it an attractive option for flexible withdrawals. Also, unlike a home equity loan, HELOCs typically use variable rates, which can fluctuate based on national economic factors. This can make your monthly payments change from month to month, which might make it more challenging to build a budget.

LEARN MORE: HELOC vs Cash Out Refinance

Personal loans

Personal loans use your credit rating to earn an unsecured loan. Most unsecured personal loans will have higher interest rates and lower borrowing limits. Home equity loans, HELOCs, and cash out refinances are secured by using your home as collateral and can all typically offer lower rates than personal loans.

Closing thoughts: Cash out refinance

It’s important to carefully consider the costs and risks associated with this type of refinancing. You should make sure to have a solid plan for using the cash you receive from a cash out refinance, so that you can avoid taking on additional debt or putting your home at risk.