Cashout Home Loans

What Is a Cash-Out Refinance?

Let’s talk mortgage basics. There are two main types of mortgage refinances available to homeowners. There is the standard rate and term refinance, which allows a borrower to obtain a lower mortgage rate and/or shorten their loan term, while keeping their existing loan balance intact. And then there is the “cash-out refinance,” which allows a borrower to tap into the equity (or cash) in their home.

Put simply, if you’ve paid down your current mortgage balance and/or home prices have increased since purchase, you may have equity in your home that you can access via cashout refinancing to use for other expenses, such as funding home improvements, paying for college tuition, or paying off credit cards.

With today’s mortgage rates so attractive, it might be possible to refinance your mortgage, get cash out, and obtain a lower interest rate, all in one transaction. This might be especially true if the value of your home has increased significantly since you took out your original mortgage.

Let’s learn more about what a cashout refi is, the pros and cons, and how this loan option can quickly replenish your savings account to pay for other bills.

How does a cash-out refinance work?

  • Like a typical mortgage refinance
  • You replace your existing home loan with a new one
  • But the new loan balance will be higher thanks to the cashout loan
  • To account for any additional cash out (home equity) you take
  • That cash can then be used for whatever purpose you wish

When mortgage refinancing, if a borrower elects to take “cash out” in addition to changing the rate and term of their existing home loan, the new mortgage balance will be larger than the original. That’s right, these funds don’t appear out of thin air, nor is it free money, even though you get cash in hand!

I kind of liken this to the old line, “Do you want fries with that?” But instead it’s, “Do you want cash out with your home refinance?”

In short, you’re taking out a larger loan when you execute a cash out refinance, which means monthly payments will likely be higher. You can use my mortgage payment calculator to see how much more you’ll pay each month.

Once the refinance loan is complete, the new loan will consist of the original balance prior to the refinance plus the desired cash out amount, less closing costs. So expect both the size of your mortgage and your mortgage payment (depending on interest rates) to increase in return for a cold, hard lump sum of cash.

As noted, if you are able to snag a lower interest rate and get cash from your home, you’ve hit a home run! You’re saving money and you’ve got money in the bank.

Refinance Your Mortgage or Open a Line of Credit

  • You may have the option to refinance your first mortgage
  • Or simply open a second mortgage behind it
  • Such as a HELOC or home equity loan
  • To avoid restarting your loan term and/or losing your low interest rate

If you’ve got ample equity in your home, you’ve got multiple refinance options at your disposal, along with another loan type that won’t disrupt your loan term and payoff goals.

There are essentially two main ways a borrower can tap into their home equity.

They can either open up a home equity loan or home equity line of credit, also known as a HELOC, behind their existing first mortgage, or refinance their current mortgage(s) and take cash out in the process.

Let’s look at an example where a homeowner wishes to get $100,000 cash out of their home:

Home value: $500,000
Existing liens: $300,000 (fancy way of saying current loan balance)
Home equity: $200,000

In the above example, the homeowner has an existing mortgage balance of $300,000. The home has a current market value of $500,000, so the homeowner has $200,000 in home equity. In other words, the homeowner essentially owns $200,000 of their home, or 40% of the current property value.

As mentioned, if the homeowner wishes to tap into that equity, they can either get a second mortgage (HELOC or home equity loan) or execute a cash-out refinance.

Let’s assume the homeowner opts to add a second mortgage via a HELOC:

Home value: $500,000
Existing liens: $300,000
HELOC: $100,000 (behind the 1st mortgage)
Home equity: $100,000

In the above example, the homeowner adds a second mortgage behind their existing $300,000 first mortgage. The $100,000 home equity line they added increases their existing loan balance to $400,000, and subsequently lowers the equity in their home to $100,000.

But the homeowner now has a $100,000 credit line (tied to the prime rate) to use for whatever they wish, without changing the rate or term of the current loan. This is NOT a cash-out refinance.

Now let’s assume they execute a cash-out refinance by refinancing their existing loan and adding cash out:

Home value: $500,000
Existing liens: $300,000
Cash-out refinance: $400,000 ($400,000 new 1st mortgage, no 2nd mortgage, $100k cash goes to borrower)
Home equity: $100,000

In this example, the homeowner refinances their original $300,000 mortgage and takes an additional $100,000 cash out, creating a new $400,000 mortgage.

The amount of equity and cash to the borrower are the same in this scenario as in the first example.

The only difference is that the homeowner still has a single home loan, as opposed to two mortgage loans, although it’s a completely new mortgage with a brand new term and possibly a new interest rate, quite likely with a different bank or mortgage lender.

So which approach works best? There are pros and cons and it really depends on the borrower. When looking to execute a cash-out refinance, it’s important to decide which method makes sense for your unique financial situation.

If interest rates are low at the time you’re looking to cash out, you may want to refinance your existing mortgage and consolidate the old mortgage and cash out into a single loan as we saw in the last example.

If mortgage rates aren’t favorable but you still need cash, it’d probably be best to leave your first mortgage alone and add a second mortgage behind it. That way it won’t affect the interest rate of the first mortgage.

Things like remaining loan term must also be taken into account. If your mortgage is close to being paid off, it may be wise to leave it untouched and opt for pulling cash out via a second mortgage.

But if your mortgage is new and the interest rate is not all that favorable (or adjustable), it might make more sense to refinance the whole kit and caboodle. In any case, there are refinance calculators out there to aid you in your decision.

Why do people pull cash out of their homes?

Home improvements
• Other investments (stocks, bonds, etc.)
• Vacations and other luxuries
• College tuition
• Home buying (to purchase another property)
• To pay-off other higher-interest-rate debt, such as credit cards or auto loans
• Pay off student loans or a personal loan
• For an emergency (buffer their checking account)
• Because they want cash for any number of reasons

There are countless reasons to refinance depending on your financial goals.

While a rate and term refinance can be helpful to lower your monthly payments and/or drop mortgage insurance, cash out refinance loans are good for, well, getting cash.

Many homeowners use cash-out refinances for debt consolidation, home improvement, or for future investments. To avoid paying high-interest rate credit card debt, homeowners may use cash out to pay off those bills.

Instead of paying a 20% interest rate or higher on a credit card each month, you can pay off that balance using your mortgage and pay a rate of 5-8% instead. Just realize the risk involved if you fail to make your mortgage payments. And consider a balance transfer instead if it’s just credit cards, you might be able to get 0% APR for a lengthy period of time.

Other homeowners may pull cash out to make improvements to their home that will increase the market value significantly, which over time can lower their loan-to-value ratio and increase the equity in their home.

Others may pull cash out if they feel they can invest the money at a better rate of return than the mortgage rate.

The question you need to ask yourself is whether it makes sense financially to refinance your current mortgage to take advantage of anything mentioned above. Keep in mind that there are fees associated with taking out a second mortgage, and even more if you plan on refinancing your first mortgage and taking cash out.

While a cash-out refinance can provide homeowners with much needed help in a dire situation, when you cash out, you essentially reset the mortgage clock and lose all the equity you’ve spent years building. Not only do you lose your equity, but you also take on more debt.