What Is a Cash-Out Refinance?

A cash-out refinance is a mortgage refinancing option that lets you convert home equity into cash. A new mortgage is taken out for more than your previous mortgage balance, and the difference is paid to you in cash.

In the real estate world, refinancing in general is a popular process for replacing an existing mortgage with a new one that typically extends terms to the borrower that are more favorable. By refinancing a mortgage, you may be able to decrease your monthly mortgage payments, negotiate a lower interest rate, renegotiate the periodic loan terms, remove or add borrowers from the loan obligation, and, in the case of a cash-out refinance, access cash from the equity in your home.

How a Cash-Out Refinance Works

A cash-out refinance allows you to use your home as collateral for a new loan as well as some cash, creating a new mortgage for a larger amount than what is currently owed. Getting cash by using the equity in your home can be an easy way to get funds for emergencies, expenses, and wants.

Borrowers seeking a cash-out refinance find a lender willing to work with them. The lender assesses the current mortgage’s terms, the balance needed to pay off the loan, and the borrower’s credit profile. The lender makes an offer based on an underwriting analysis. The borrower gets a new loan that pays off their previous one and locks them into a new monthly installment plan. The amount above and beyond the mortgage payoff is issued in cash.

With a standard refinance, the borrower would never see any cash in hand, just a decrease to their monthly payments. The funds from a cash-out refinance can be used as the borrower sees fit, but many typically use the money to pay for big expenses such as medical or educational fees, to consolidate debt, or as an emergency fund.

A cash-out refinance results in less equity in your home, which means that the lender is taking on greater risk. As a result, closing costs, fees, or interest rates can be higher than a standard refinance. Borrowers with specialty mortgages like U.S. Department of Veterans Affairs (VA) loans, including cash-out loans, can often be refinanced through more favorable terms with lower fees and rates than non-VA loans.

Pros and Cons of a Cash-Out Refinance

Savvy investors watching interest rates over time typically will jump at the chance to refinance when lending rates are falling toward new lows. There can be a variety of different types of options for refinancing, but in general, most will come with several added costs and fees that make the timing of a mortgage loan refinancing just as important as the decision to refinance.

In addition to checking rates and fees to make sure that refinancing is a good option, consider your reasons for needing the cash. This refinancing option typically comes with lower interest rates than unsecured debt, like credit cards or personal loans, does. However, unlike a credit card or personal loan, you risk losing your home—if you can’t pay your mortgage, for example, or if the value of your home goes down and you end up underwater on your mortgage.

Carefully consider if what you need the cash for is worth the risk of losing your home if you can’t keep up with payments in the future. If you need the cash to pay off consumer debt, take the steps you need to get your spending under control so you don’t get trapped in an endless cycle of debt reloading. The Consumer Financial Protection Bureau (CFPB) has a number of excellent guides to help determine if a refinance is a good choice for you.

The cash-out refinance gives the borrower all of the benefits they are looking for from a standard refinancing, including a lower rate and potentially other beneficial modifications. Borrowers also get cash paid out to them that can be used to pay down other high-rate debt or possibly fund a large purchase. This can be particularly beneficial when rates are low, or in times of crisis—such as in 2020–21, in the wake of global lockdowns and quarantines, when lower payments and some extra cash may have been very helpful.

Example of a Cash-Out Refinance

Say you took out a $200,000 mortgage to buy a property worth $300,000, and, after many years, you still owe $100,000. Assuming that the property value has not dropped below $300,000, you have also built up at least $200,000 in home equity. If rates have fallen and you are looking to refinance, you could potentially get approved for up to 80% of the equity in your home, depending on the underwriting.

Many people wouldn’t necessarily want to take on the future burden of another $200,000 loan, but having equity can help the amount you can receive as cash. Let’s say your lender is willing to lend out 75% of your home’s value. For a $300,000 home, this would be $225,000. You need $100,000 to pay off the remaining principal. This leaves you with $125,000 in cash.

In other words, you can assume a new $150,000 mortgage, get $50,000 in cash, and begin a new monthly installment payment schedule for the full amount. That’s the advantage of collateralized loans. The disadvantage is that the new lien on your home applies to both the $100,000 and the $50,000, since it is all combined together in one loan.

Rate-and-Term vs. Cash-Out Refinance

As mentioned above, borrowers have a variety of options when it comes to refinancing. The most basic mortgage loan refinance is rate-and-term refinance, also called no cash-out refinancing. With this type, you are attempting to attain a lower interest rate or adjust the term of your loan, but nothing else changes on your mortgage.

For example, if your property was purchased years ago when rates were higher, then you might find it advantageous to refinance to take advantage of lower interest rates. In addition, variables may have changed in your life, allowing you to handle a 15-year mortgage (saving massively on interest payments), even though it means giving up the lower monthly payments of your 30-year mortgage. With a rate-and-term refinance, you could lower your rate, adjust to a 15-year payout, or both. Nothing else changes, just the rate and term.

Cash-out refinancing has a different goal. You receive the difference between the two loans in tax-free cash. This is possible because you only owe the lending institution what is left on the original mortgage amount. Any extraneous loan amount from the refinanced, cash-out mortgage is paid to you in cash at closing, which is generally 45 to 60 days from when you apply.

Compared to rate-and-term, cash-out loans usually come with higher interest rates and other costs, such as points. Cash-out loans are more complex than a rate-and-term and usually have higher underwriting standards. A high credit score and a lower relative loan-to-value (LTV) ratio can mitigate some concerns and help you get a more favorable deal.

Cash-Out Refinance vs. Home Equity Loan

With a cash-out refinance, you pay off your current mortgage and enter into a new one. With a home equity loan, you are taking out a second mortgage in addition to your original one, meaning that you now have two liens on your property. This translates to having two separate creditors, each with a possible claim on your home.

Closing costs on a home equity loan are generally less than those for a cash-out refinance. If you need a substantial sum for a specific purpose, home equity credit can be advantageous. However, if you can get a lower interest rate with a cash-out refinance—and if you plan to stay in your home for the long term—then the refinance probably makes more sense. In both cases, make sure that you are able to repay the new loan amount because otherwise, you could end up losing your home.