Cash-Out Refinance: What You Need to Know

Sometimes you might find yourself needing a sizable amount of money to accomplish a goal, such as paying off high-interest credit card debt or tackling a much-needed home improvement project. A cash-out refinance on your home can help by giving you funds from your home equity. However, this is a significant financial decision that should be carefully considered.

In this guide, you'll find these topics covered:

• What is a cash-out refinance?
• 4 important things to know about cash-out refinances
• Benefits and potential drawbacks of a cash-out refinance
• When is a cash-out refinance a good option?
• What do I need for a cash-out refinance?
• How to apply for a cash-out refinance
• Alternatives to cash-out refinancing

What Is a Cash-Out Refinance?

A cash-out refinance is a type of mortgage refinancing that lets homeowners change some of their home equity into cash. It replaces your existing mortgage with a new loan. After the payoff of the current mortgage balance and closing costs (net loan amount), you’ll be paid the rest in cash.

For example, if your home is worth $300,000 and you owe $200,000 on your current mortgage, you have $100,000 in home equity. With a cash-out refinance, you might take out a new loan for $250,000. Then you would pay off your existing $200,000 mortgage and receive $50,000 in cash (minus closing costs).

4 Important Things to Know About Cash-Out Refinances

By refinancing for more than you currently owe on your home, you’ll get quick access to money you can use. Before you sign on the dotted line, make sure you understand these key facts about cash-out refinances.

1. Your refinanced mortgage replaces your old mortgage.

A cash-out refinance completely replaces your existing mortgage with a new one. You’ll have new loan terms and your amortization schedule will be reset. You’ll also have a chance to review your mortgage options before choosing a new one, which will have its own interest rate and repayment period. Just like when you took out your previous mortgage, a larger portion of your initial payments will go toward interest instead of the principal in the beginning of your mortgage term based on your amortization schedule.

2. You’ll likely pay more for a cash-out refinance, and for longer.

Taking out cash against your home's equity means you're borrowing more money than what you owe and extending the remaining term of your existing mortgage. You'll have a higher monthly mortgage payment and a potentially longer loan term. This means you'll pay more in interest over the life of the loan depending on your new loan amount and terms. Consider keeping or even shortening your loan term to save on long-term interest costs based on your affordability and financial interest. Shorter terms will have higher monthly payments.

3. You may be able to lower your mortgage loan’s interest rate.

A cash-out refinance might offer an opportunity to get a lower interest rate. That can depend on market conditions and your financial situation. Cash-out refinance rates may also be lower than interest rates for home equity loans or home equity lines of credit (HELOCs). Always compare rates, terms and loan options from multiple mortgage lenders to ensure you’re getting the best deal possible.

4. You’ll need to pay closing costs.

Like your original mortgage, a cash-out refinance comes with closing costs, typically ranging from 2% to 5% of the loan amount. You may be able to roll these costs into your new loan, but doing so reduces how much cash you get and increases your loan balance.

Benefits and Potential Drawbacks of a Cash-Out Refinance

A cash-out refinance can be a powerful financial tool when used wisely, but it’s important to prepare for potential risks. Before accessing your equity, carefully weigh the pros and cons.

How can I use the money from a cash-out refinance?

You can use the funds to meet your personal needs, including home improvements, debt consolidation, education expenses or creating an emergency fund.

How much money can I get with a cash-out refinance?

Most lenders generally allow you to borrow up to 80% of your home’s value. The exact amount depends on your home’s value, your existing mortgage, your credit score, your income, occupancy and lender policies.

How long do I have to wait to get a cash-out refinance?

Generally, you need to have owned your home for at least 12 months. Requirements may vary by lender and can be affected by various factors like your credit score and home equity.

Does cash-out refinancing hurt your credit score?

A cash-out refinance can cause a short-term dip due to the credit inquiry and new account. If you make timely payments and your overall credit utilization becomes low, the long-term impact may be minimal or positive—especially if you use the funds to pay down other debts.

Do I have to pay taxes on a cash-out refinance?

The cash you receive is not considered taxable income. Whether the interest is tax deductible may depend on your situation. Consult a tax professional for advice on your specific financial situation.^{Footnote 1}

When Is a Cash-Out Refinance a Good Option?

A cash-out refinance helps you access money that’s tied up in your home, but it’s not right for every situation. Here are some examples of when a cash-out refinance is a good idea:

• You have high-interest debts that could be consolidated at a lower rate.
• You’re planning home improvements that may increase your property’s value.
• Your home’s value has increased significantly since you purchased it.
• Your financial situation has improved, potentially helping you qualify for better terms.
• You have at least 20% equity in your home after the refinance to avoid owing PMI.
• You plan to stay in your home long enough to recoup the closing costs.

Remember, a cash-out refinance increases your mortgage debt and uses your home as collateral. Always carefully consider your financial outlook and ability to repay before applying.

What Do I Need for a Cash-Out Refinance?

Like any loan, lenders have specific criteria for cash-out refinancing. Here’s a general overview of the requirements you’ll typically need to meet:

Criteria	General Requirements
Credit Score	Minimum 620, but 700+ for better interest rates
Loan-to-Value (LTV) Ratio	Maximum 80% of home’s value
Debt-to-Income (DTI) Ratio	Generally not exceeding 43%
Home Equity	At least 20% remaining after refinance
Income	Proof of stable, sufficient income
Employment	At least 2 years of consistent employment
Property Type	Primary residence, second home or investment property
Payment History	No late payments in the last 12 months
Home Appraisal	Current appraisal required
Length of Homeownership	Typically at least 12 months

These criteria help determine your eligibility and affect the terms and interest rates you may be offered. Always consult with your lender for your qualification and available options.

How to Apply for a Cash-Out Refinance

Applying for cash-out refinancing is a lot like applying for a mortgage. Here’s a quick overview of what you can expect:

1. Prepare and research. Consider your financial situation, including credit score and home equity. Research and compare offers from multiple lenders. Pay special attention to interest rates, terms, fees and affordability. The lender may require a professional appraisal, so you may want to research your home’s value, too.
2. Gather documents and apply. Collect necessary documents (pay stubs, tax returns, bank statements, etc.) and submit your application to your lender. Be prepared to provide information about your current mortgage and the intended use of funds.
3. Get approved and close on your loan. Once you applied, you’ll receive the loan estimate detailing terms and closing costs. Your lender will review your application and determine your loan approval. It’s important that you need to review the approved terms carefully to accept the loan approval before attending the closing to sign final documents.
4. Receive your funds. After closing, your old mortgage will be paid off and you’ll receive the cash-out portion as specified in your agreement.

The process can take several weeks from application to closing. Stay in touch with your lender and promptly provide any requested information to keep things moving smoothly.

Alternatives to Cash-Out Refinancing

A cash-out refinance can be a useful financial tool, but it’s not the only way to access your home equity. Alternatives include home equity loans and HELOCs. Both have their own pros and cons when compared with a cash-out refinance.

Cash-Out Refinance vs. Home Equity Loan

• A cash-out refinance replaces your existing mortgage, potentially offering lower interest rates but with higher closing costs. It can be a good option if you want to change the terms on your first mortgage.
• A home equity loan is a second mortgage with a fixed rate and term. Consider this option if you prefer a separate, fixed-payment loan.

Cash-Out Refinance vs. HELOC

• A cash-out refinance provides a lump sum with typically fixed rates and payments. Consider this option for large, one-time expenses.
• A HELOC offers revolving credit with variable rates and flexible payments during the draw period. It may be ideal for ongoing costs or if you need more flexibility in accessing funds.

Explore Navy Federal Credit Union’s Home Equity Solutions

Cash-out refinancing can be a smart way to use your home’s equity, but it’s not the only option. At Navy Federal, we offer home equity borrowing options tailored to our members, with competitive rates and expert guidance to help you make the most of your home’s value.