By Matt Allen
Vice President, Portfolio Lending (NMLS #415037)

How Does a Cash-Out Refinance Work?

Jun 23, 2022

  • Cash-out Refinance
  • Refinancing

Are you looking to refinance your mortgage and get additional money to meet other needs? A cash-out refinance may be the right option for you. With a cash-out refinance, you are taking out a new mortgage for an amount greater than your current mortgage. The difference between these two mortgages is given to you as cash. The cash from cash-out refinancing can be used for home improvements, repairs, debt consolidation to pay off credit card debt, starting a business, medical costs, or other additional needs.

How to Qualify for a Cash-Out Refinance

It would be best if you have a good amount of built-up equity in your home for a cash-out refinance. The equity is the money you are borrowing against for the cash portion of the loan.

Let's look at an example to understand how this would work. Let's say you have a home worth $350,000, and your existing mortgage loan is $200,000. That means you have $150,000 of home equity in your home. The lender generally wants you to have at least 20% equity in your home after a refinance. You currently have about 42% equity in your home. So, if you wanted to borrow an additional $50,000 in addition to the $200,000 you already owe, you would still meet the 20% equity most lenders are looking for.

Credit Requirements for a Cash-Out Refinance

In addition to the equity requirement, you must meet the lender’s credit qualifications. These requirements vary by lender, but there are some general guidelines that most lenders follow. Most lenders require a credit score that's 620 or higher, though there are programs that may allow lower scores and a debt-to-income ratio of less than 50%. Your DTI ratio takes all your monthly debt payments and divides them by your gross monthly income. For example, if you have $1,000 in monthly mortgage and other debt payments and make $5,000 monthly, your DTI would be 25%. This is calculated by taking the $1,000 and dividing it by $5,000.

What Are the Benefits and Considerations for a Cash-Out Refinance?

A cash-out refinance may sometimes be a better option than other loan alternatives. A mortgage refinance loan is a secured loan type because you are borrowing against your home's value. Therefore, it may offer a lower interest rate than other non-secured loan options. The cash can consolidate debt and combine it into one convenient payment.

If you have revolving balances on your credit cards that have higher interest rates, a cash-out refinance could allow you to lower the interest rate on those balances. It could save you money in the interest you have to pay back on those balances. Here's a calculator that can help you determine if you will save money with a cash-out refinance debt consolidation.

You might also be able to receive a mortgage interest tax deduction on your cash-out refinance. This is the case if you use the funds to pay for buying, building, or improving your home. As an additional benefit, these improvements could help raise your home value.

Before taking a cash-out refinance loan, you need to consider that, since you are using your home as collateral, this loan type is subject to foreclosure risk. If you are unable to make timely payments on a cash-out refinance, you could risk losing your home if you can't repay the loan. Unsecured credit card balances are not subject to the same foreclosure risk.

Since a cash-out refinance is a new mortgage loan, it will have different terms than your original loan. Make sure that the interest rate and fees you agree to are worth moving to a cash-out refinance. Closing costs can range from two to five percent of the loan's value, which could eat into those savings.

Are you ready to refinance your mortgage and save money? Click here for more information about a cash-out refinance with NASB or call our experts at 855-465-0753 today and get started.