Cash Out Refinance: Loan Explained

By Courtney Christensen on July, 8 2020
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Courtney Christensen

Do you have dreams of renovating your kitchen? Would you like to add a pool to your backyard? Are there debts you’d like to pay off? A cash out refinance loan may help you accomplish any of these, and so much more. 

With a cash out refinance, you borrow against the equity in your home in order to liquidate it into cash you can use for large purchases. So, could you use the extra cash?

What is a Refinance Loan and Why Should You Consider It?

In the simplest terms, a refinance is a do-over. You replace your current mortgage with an entirely new one. Anything you owed on your old mortgage is paid off, and you start fresh with a brand new loan. You can even choose another mortgage lender to do your refinance if you struggled with the company that gave you your first mortgage.

While refinancing isn’t for everyone, it can be a smart financial decision for many homeowners. When researching your options and deciding whether a refinance is a good choice for you, remember these guidelines:

  • You should have owned your home for at least 5 years in order to benefit from a cash out refinance.
  • Watch the market for changes in interest rates – strike when the market is offering a lower interest rate than you currently have.
  • Refinancing saves money in the long run, but you may need to pay upfront closing costs.
  • You should have a decent credit score.

Why Should You Choose a Cash Out Refinance Loan?

You have many options when it comes to refinancing: rate and term refinance, renovation refinance, streamline refinances, and a cash out refinance. All of these come with their own pros and cons, but the process of obtaining all of these loans is relatively similar.

With a cash out refinance, you are taking the money you’ve already paid into your home and turning it into cash. So, if you’ve lived in your home for 5 or more years, you likely have a good chunk of money saved up as equity in your home. While usually inaccessible, your equity can be turned into cold hard cash with a refinance.

The process goes a little like this:

  1. You tell your lender how much money you would like to take out of your equity.
  2. Your lender repays the remainder of your mortgage.
  3. Your lender creates a new loan with that remainder plus the equity you’ve borrowed.

This likely means that you will be adding more years onto your mortgage, but you get to see immediate benefits. Some borrowers use a cash out refinance to make home improvements, purchase vehicles, or pay for college. This big purchases are perfect for a cash out refinance. However, it’s not the only thing a cash out refinance is good for.

Consolidating debt is a major reason homeowners choose a cash out refinance. With credit card and student loan debts on the rise, using your equity to repay these debts just makes financial sense. Credit cards in particular have very high interest rates – sometimes even 15 or 20 points higher than your mortgage. By repaying these debts with your equity, you are trading a 20% interest rate with a 3% interest rate (on average). You’ll end up paying much, much less in the long run.

Additionally, paying off these debts in full will boost your credit score almost instantly. Your credit score is based off the timeliness of monthly payments, the frequency with which you take out new loans, how much debt you have, and the ratio of your income to your debt. Once you pay off a large credit card debt, you remove that debt from your credit and improve your debt-to-income ratio as you no longer have to pay back that debt every month.

A cash out refinance loan may not be for everyone, but by talking with a mortgage professional, you can figure out the best course of action for you and your family. They will be able to help you learn your home’s value (which is probably different now than when you purchased it), the interest rates you qualify for, and how much equity you could borrow. It’s also never a bad idea to shop around for different interest rates and lenders.

Learn more about cash out refinances and other refinance loans with our refinancing eBook  Click the button below to download your free copy.  

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