Dear Money Mentor: What is cash-out refinancing and is it right for you?

Turning the equity in your home into cash can help you pay for things like home improvements and high-interest debt. Here’s what you need to know before deciding if cash-out refinancing is the right product for you. 

If you own a home, chances are you’ve built some equity. That’s the difference between what you owe and how much your home is worth. If you need cash, tapping into this equity might be a good option and a cash-out refinance is one way to do it. We spoke with U.S. Bank mortgage sales officer Marketa Shouse to help us understand what a cash-out refinance is all about. 

What is a cash-out refinance?

“In simple terms, a cash-out refinance allows you to tap into your home equity by replacing your current mortgage with a new, larger mortgage,” Shouse says. “You get the difference in cash between the new mortgage amount and your previous mortgage payoff.” 

How much cash you can get depends upon your home value. In general, you can borrow up to 80% of your home’s market value.   

What is it good for? 

You might be wary of refinancing your home when interest rates are high. But Shouse says, “there is no cheaper way to borrow money than using your home as collateral.” Still, you must be careful. “As with any home loan, if you can’t make the payments, you risk losing your house.” 

With that in mind, it’s a good idea to use the money in ways that will give you a return on your investment, for example home improvement projects that add equity to your home, for investment opportunities like buying a rental property, or to pay for school.  

It’s also a good option for paying down high-interest debt. Refinance rates are usually lower than credit cards or personal loans, so it allows you to consolidate multiple loans into one loan with a single lower-cost monthly payment.  

“This is a really good option for people who can’t qualify for other types of home loans,” according to Shouse. “Sometimes, people don’t have the credit score required to get a home equity loan (HEIL) or home equity line of credit (HELOC), or they’ve taken advantage of a COVID forbearance or loan modification that limits their eligibility for these other products that use their home as collateral.” 

How much can you get?  

Most lenders allow you to borrow up to 80% of your home’s value. If you still have a balance on your original mortgage, you’ll have to subtract that from the cash you could receive. 

As an example, if you have a home worth $250,000, the maximum loan you could take out would be 80% of the home's value or $200,000. Subtract what you owe on your current loan, perhaps its $150,000, and you could get back up to $50,000 in cash at closing. 

Shouse says to “keep in mind, lenders will require you to get an appraisal to determine your home's value and you’ll need to pay closing costs and fees, which can total 2%-5% of the new mortgage. That comes out of the amount of cash back you’ll be getting.” 

What are the cash-out refinance requirements? 

Requirements vary by lender (so do rates!) so it’s a good idea to shop around. But in general, here are some of the main requirements: 

• Credit score: While you don’t have to have great credit, the better your credit score the better your interest rate will be. Many lenders will secure a cash-out refinance for people who have a credit score in the 600s. 
• Debt-to-income ratio (DTI): This is the amount of debt you have each month (mortgage, bills, etc..) divided by your monthly income. Usually, you need a DTI of 50% or less.  
• Home equity: Most lenders require that you maintain at least 20% equity in the home. Equity is the difference between what your home is worth and what you owe your lender. 

What’s the difference between a cash-out refinance and a home equity loan and line of credit?

The main difference is that a cash-out refinance replaces your current mortgage while a home equity loan or line of credit is a second mortgage -- you pay it while also paying your current mortgage. 

The rate for a cash-out refinancing is generally lower than for a home equity loan or line of credit, and depending on the market, could be lower than your current mortgage rate.  

A cash-out refinance usually comes with closing costs, but if you use the money to make home repairs or improvements you may be able to deduct the mortgage interest from your taxes. 

Learn more about Cash-out refinancing at U.S. Bank and other refinancing options. Ready to take the leap? Find a mortgage loan officer and we’ll help you get started on your way.