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What is cash-out refinancing?
Cash-out refinancing replaces your current home loan with a bigger mortgage, allowing you to take advantage of the equity you’ve built up in your home and access the difference between the two mortgages (your current one and the new one) in cash. The cash can go toward virtually any purpose, such as home remodeling, consolidating high-interest debt or other financial goals.
How a cash-out refinance works
The process for a cash-out refinance is similar to a rate-and-term refinance of a mortgage, in which you simply replace your existing loan with a new one for the same amount, usually at a lower interest rate or for a shorter loan term, or both. In a cash-out refinance, you can do the same, and also withdraw a portion of your home’s equity in a lump sum.
“Cash-out refinancing is beneficial if you can reduce the interest rate on your primary mortgage and make good use of the funds you take out,” says Greg McBride, CFA, Bankrate chief financial analyst.
For example, say the remaining balance on your current mortgage is $100,000 and your home is currently worth $300,000. In this case, you have $200,000 in home equity. Let’s assume that refinancing your current mortgage means you can get a lower interest rate, and you’ll use the cash to renovate your kitchen and bathrooms.
Since lenders generally require you to maintain at least 20 percent equity in your home (though there are exceptions) after a cash-out refinance, you’ll need to have at least $60,000 in home equity, or be able to borrow up to $140,000 in cash. You’ll also need to pay for closing costs like the appraisal fee, so the final amount could be less.
You tend to pay more in interest after completing a cash-out refinance because you’re increasing the loan amount, and like other loans, you’ll have to pay for closing costs. Otherwise, the steps to do this kind of refinance should be similar to when you first got your mortgage: Submit an application after selecting a lender, provide necessary documentation and wait for an approval, then wait out the closing.
1. Determine the lender’s minimum requirements
Mortgage lenders have different qualifying requirements for cash-out refinancing, and most have a minimum credit score – the higher, the better. The other typical requirements include a debt-to-income ratio below a certain percentage and at least 20 percent equity in your home. As you explore your options, take note of the requirements.