Definition
A cash-out refinance is a type of mortgage refinancing where a homeowner replaces their existing mortgage with a new loan for a higher amount than they currently owe, receiving the difference in cash. Homeowners typically use this option to tap into their home’s equity for purposes such as home improvements, debt consolidation, or other major expenses.
Explanation
Unlike a standard refinance, which simply replaces the existing loan with a lower interest rate or better terms, a cash-out refinance allows homeowners to borrow more than they owe on the property. The extra funds come from the equity built in the home and are given to the homeowner as a lump sum.
Most lenders allow homeowners to borrow up to 80% of the home’s value, though some government-backed loans (such as VA cash-out refinances) may allow for higher limits. Since a cash-out refinance replaces the original mortgage, the homeowner must go through the loan approval process again, including credit checks, income verification, and an updated home appraisal.
This option is attractive because mortgage interest rates are often lower than credit card or personal loan rates, making it a cost-effective way to access funds. However, it also increases the mortgage balance, meaning the homeowner will have a larger monthly payment and potentially pay more interest over time.
Example
A homeowner’s property is worth $400,000, and they currently owe $200,000 on their mortgage. They decide to do a cash-out refinance for 80% of their home’s value, which is $320,000.
- The lender pays off the existing $200,000 mortgage.
- The homeowner receives the remaining $120,000 in cash, which they can use for renovations, debt payoff, or other expenses.
- The homeowner now has a new mortgage of $320,000, likely with new loan terms and monthly payments.