Quick question: what would you do if you had extra cash? We’ll call this the million dollar question!
Would you make improvements to your home? Pay off credit card bills? Start a savings account or college fund for your kids? Go on a dream vacation? Throw the best Super Bowl party of all time?
While these options might seem like pipe dreams, the good news is if you’re a homeowner, you have the power to put cash in your pocket through a cash out refinancing!
You might be thinking, “That sounds too good to be true. How does a cash out refinancing work?” Don’t worry, the home loan experts at First Mortgage Direct are here to answer all of your refinancing questions. Check out our comprehensive guide to cash out refinancing below, or reach out to speak directly with one of our loan officers and start your refinancing journey.
First Mortgage Direct’s Guide to Cash Out Refinancing
To understand how cash out refinancing works, it’s important to understand exactly what refinancing is. Simply put, refinancing means you’re trading in your current home mortgage for a new one.
How does a cash out refinancing work?
The cash out refinancing process is just like any other mortgage refinancing. You’re still replacing your old loan with a new one typically at a lower interest rate or with a different length of your loan term.
With a cash out refinance, however, you can take advantage of the equity you’ve built in your home by receiving the difference between your old mortgage and your new one as cash in your pocket. Your new loan total is then the combination of your previous remaining balance and whatever you took out of your equity.
For a general example:
- Your house is worth $400,000 and your current mortgage has a $200,000 remaining balance. That means your equity in your home is $200,000, or 50% of your home’s worth.
- Lenders typically prefer you maintain at least 20% equity in your home when cash out refinancing, so in this situation you would need to keep $80,000 in your home.
- 20% of $400,000 = $80,000
- That means you could borrow up to $120,000 ($200,000 – $80,000 = $120,000) in cash, barring appraisal fees and other closing costs.
What is equity?
Equity is the difference between what you owe on your home and the amount your home is actually worth. This equity can be beneficial in lots of ways, but with a cash out refinance you can actually turn that equity into cold hard cash. If your home has increased in value since you bought it, you might have more equity than you think!
How cash out refinancing differs from other refinancing options
Where cash out refinancing differs is its limitations. With other refinancing options, you can qualify with a higher loan-to-value ratio. This means it’s easier to get the new loan if you have poorer credit, because you’re borrowing a higher percentage of what the home is worth. You can also borrow with up to 95% of your equity when doing a traditional rate-and-term refinancing.
With a cash out refinancing, however, most lenders will only allow you to borrow with up to 80% of your equity. But, that borrowing converts directly to cash in your pocket, instead of going toward your new refinanced mortgage.
Ultimately the goal of refinancing, whether cash out or rate-and-term, is to lower your total payment and benefit you financially. For a full breakdown of the differences between these refinancing options, contact us and talk with one of our home loan experts.
How much cash can you actually take out?
Everyone’s financial situation is different, so how much money you can actually receive through cash out refinancing depends on your unique situation.
There are certain situations, like when refinancing a VA loan, where a borrower can withdraw 100% of their equity. You also don’t have to take out all of your available equity when refinancing. The best way you can determine the right refinancing option for you is to speak to a loan officer about your unique situation.
How long after you buy your home can you take a cash out refinance?
We recommend homeowners wait until 6 months after their initial loan to refinance, but you’re free to pursue refinancing options at any point during the life of your mortgage.
With a cash out refinance specifically, the more equity you have built into your home, the more you can borrow. Usually the longer you’ve been in your home, the more equity you own, but there are also factors that can affect your equity, like If your home has increased significantly in value or if loan rates have dropped since purchasing.
We consider all of these factors and more when discussing refinancing options with our clients. FMD loan officers are committed to setting our clients up with the best possible mortgage options, so they can take their next steps toward a better future.
How can you use a cash out refinance?
Now that we’ve answered the question “How does a cash out refinancing work?”, you might be wondering how you can use this money. Since you’re receiving cash in hand after your refinance, there’s almost endless possibilities on how to use it. Here are just a few ways to get the most out of your cash out refinance:
In most cases, your mortgage interest rate is better than almost every other loan interest rate. By taking the money from a cash out refinance and paying off other debts, like credit card debt, you are actually lowering your overall monthly payments and saving yourself potentially thousands of dollars in interest.
Things happen in life. Maybe the transmission in your car gave out, or you have unexpected medical expenses that insurance won’t cover. A cash out refinance can help cover those expenses, all while maintaining a relatively low interest rate.
By making improvements to your home, you’re also improving your home’s value, thus increasing your equity in your home. You can also deduct the mortgage interest from your taxes when using a cash out refinance to make home improvements, as long as the project substantially increases your home’s value.
Some common home improvements that increase your home’s value include:
- Landscaping work
- Kitchen and bathroom remodeling
- Outdoor deck addition
- Transforming unused spaces like basements or extra bedrooms
- Energy efficient improvements like solar panels and energy efficient windows
- Upgraded security systems
These upgrades could not only bring you extra joy, safety, or security—they can also increase your home’s perceived value to potential buyers if your plan is to sell the property long term! For tax purposes, all of the above options qualify for a write off. As long as you’re doing more than painting a room or fixing a broken door, your tax benefits are available.
Depending on student loan interest rates, it might be cheaper long-term to pay for college education for yourself or a child through the money you receive after a cash out refinance.
The whole goal of a cash out refinance is to make your money and your equity work for you, so investing in the stock market or other investments with a high return on investment is a great use of the extra cash.
How does cash out refinancing compare to other loans?
When it comes to borrowing money, it’s tough to find a better option than cash out refinancing. For one, the rate on your mortgage will likely be better than any other traditional money loan from a bank.
A home equity line of credit or home equity loan are also options for turning your home equity into cash, but those options also typically come with a higher interest rate than a cash out refinance.
More advantages of cash out refinancing
- Streamlined process: Refinancing your home is a much more simple process than buying a home or applying for other loans. Whether you’re using your current lender or transitioning to a new lender, after underwriting you will receive a closing disclosure in advance a few days before the closing date. If everything checks out there, in most states you don’t even need to go to the lending office to complete the paperwork. A notary can be sent to your home and see you sign the documents. And with a cash out refinancing, any closing costs can just be taken out of your total lump sum.
- Right of rescission: On a refinanced home mortgage, you have the right to cancel your mortgage contract up to three business days after closing. This is called the right of rescission, and it protects you in case any major life events occur and you won’t be able to pay the new loan. It’s important to keep this in mind with a cash out refinancing since you won’t receive your lump sum payment until after the right of rescission ends.
- No need for appraisal: While some lenders may want an appraisal to get a recent value of your home, it’s not necessary with a cash out refinancing. Our underwriting system at First Mortgage Direct will determine whether an appraisal is necessary, and in many cases a refinancing can be done without one.
Can a cash out refinance combine with other refinancing options?
Refinancing is a flexible system dependent on your current financial situation. It is possible to combine a cash out refinancing with other refinancing options, like lowering your interest rate, changing your loan term length, or even reducing your monthly payments.
To fully understand your refinancing options, contact a home loan professional like our great team at First Mortgage Direct.
Still asking “How does a cash out refinancing work?” Contact an expert at First Mortgage Direct
Our experienced mortgage professionals are passionate about helping our clients take their first steps toward a better future, and knowing when to refinance your home is one of those steps.
The loan officers at First Mortgage Direct won’t pressure you into a loan that’s not suitable for your needs. We are professionals in this industry with the know-how to fit each client with a tailored loan solution. We strive for customer satisfaction, and we’re not satisfied until you are.
Contact us today to see how our approach of honesty, integrity, and experience helps you find the right home loan solutions.
A special thank you to our Senior Loan Officer, Devin McCall, for providing his expertise on this topic.