How Does A Cash-Out Refinance Work?

What Is a Cash-Out Refinance, and How Does It Work?

Before trying to understand what a cash-out refinance is, it’s important to take a moment to think about your equity.

Equity plays an important role in a cash-out refinance and is essentially the difference between the current value of your home and what you currently owe. Having a good amount of equity is crucial and fortunately, it can be increased in two ways:

  1. Increasing the value of your home

The value of your home should increase on its own over time but this increase in value can be sped up through remodeling and renovations.

  1. Mortgage payments

Each time your mortgage payment is paid, the amount you owe decreases, and your equity subsequently increases. If possible, increasing your monthly mortgage payments means more equity in less time.

A cash-out refinance utilizes this equity that you’ve built over time and allows you to cash out in return for taking out a new, larger mortgage. Essentially, your new mortgage is more than you currently owe and you’re able to cash out the difference. This cash-out can then be used for whatever your current financial goal is.

How Does A Cash-Out Refinance Work?

The process of receiving a cash-out refinance is similar to that of purchasing a new home. After choosing a lender and ensuring you meet the specified requirements, you submit an application for cash-out refinance along with the required documentation. Once your lender reviews your documents, your application should be approved and you’ll then receive your cash-out. Let’s go through each of these steps in a bit more detail.

1. Choosing a Lender

It’s important to do thorough research when choosing a lender. Because you’re taking out a new, larger loan, it’s important to have a look around to find the best refinance offers. Have a look at multiple lenders’ rates to see which can offer you the best cash-out refinance rate as well as fees.

2. Checking The Cash-Out Refinance Requirements

Each lender may have its specific requirements when deciding who is approved for a cash-out refinance. A few regular requirements include:

Having Enough Equity In Your Home

You’ll need to already have a good amount of equity built in your home if you want to secure a cash-out refinance. You won’t be able to cash out 100% of your equity as most lenders will require you to maintain at least 20% equity in your home in a cash-out refinance. However, one exception is a VA cash-out refinance, which allows you to withdraw all of your equity. You will need to take a careful look at your current equity before you commit to a cash-out refinance. Make sure that you can convert enough equity to accomplish your financial goals.

A Debt-To-Income Ratio Of Below 50%

Your current Debt-To-Income Ratio (DTI) is the total amount of your monthly debts and payments divided by your total monthly income. Most lenders do require that your current DTI be less than 50% for approval.

A Minimum Credit Score Of 620

To refinance, you’ll need a credit score of at least 580. However, when looking for a cash-out, your credit score typically will need to be 620 and above.

3. Applying

After applying for a cash-out refinance and being notified of the status of your application, your lender may request more supporting documents such as pay stubs to prove your current DTI ratio. If approved, your lender will then take you through the next steps toward closing. After closing, you can wait up to five days for your check to arrive.

Cash-Out Refinance Rates

Because cash-out refinance loans are a greater risk to the lender, their rates can be anywhere from 0.125% to 0.5% higher than rates for a no-cash-out refinance. It’s important to note that as with all mortgage loans, your cash-out refinance rate will depend on your circumstances such as your credit profile. Most lenders do require that you also pay closing costs which average between 2-6% of the total loan amount.

Is a cash-out refinance the right option for me?

Whether you’ve had some home renovations like a new kitchen in mind or perhaps some debt you’d like to get under control, a cash-out refinance is an excellent option to consider since it provides a lower-than-credit interest rate to make these goals possible.

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