With prices on everything from gas to groceries increasing by the day, it might be nice to have a bit of extra cash on hand. However, there’s a difference between wanting a bit of extra spending money for a night out or the newest gadget and wanting a more substantial amount of money for major things, like home renovations or consolidating debt.
You could go to your credit union or other lending institution and take out a personal loan, or even take out a new credit card, but both of these options tend to have higher interest rates. There is another option for those people who may be looking for a larger amount of money, however. A cash-out refinance might be in order. You might be asking yourself, what is a cash-out refinance? You also might wonder, how does a cash-out refinance work?
In this article, we’ll explain everything you need to know about a cash-out refinance:
What Does It Mean to Refinance Your Mortgage?
Before we can answer, what is a cash-out refinance and how does it work, let’s step back and answer a broader question: what is refinancing?
A refinance, or “refi,” is a process by which homeowners can adjust the terms of their mortgage. Effectively, it involves taking out a new mortgage of an amount equal to the balance remaining on your existing mortgage, using that amount to pay off your first mortgage in full, and then moving forward with paying off the new mortgage.
There are a number of reasons that someone might want to refinance their mortgage.
For instance, to lower your interest rate. Mortgage rates are currently at highs not seen since 2008, due to the Federal Reserve raising interest rates in an effort to combat inflation. Imagine buying a home today with a 6.5 percent interest rate. In five years, however, with inflation under control, the Fed’s interest rates could be much lower. Taking out a new mortgage at a lower interest rate could save you tens of thousands of dollars (or more) over the life span of your mortgage.
It doesn’t just have to be about changing interest rates. A family who has just had some unexpected expenses, like finding out they’re having twins instead of just one baby, might refinance for a longer mortgage and pay more over time while reducing their monthly expenses.
On the other hand, a family who has just had an unexpected financial benefit like an inheritance windfall or a raise at work might opt for the opposite, paying more every month to shorten the overall term of the mortgage so they can pay less in the long run.
How Does a Cash-Out Refinance Work?
What if you access your home equity and take out a new mortgage for more than the exact amount you have remaining on your first mortgage?
In essence, this is what a cash-out refinance is. Rather than a new mortgage for the same amount you owe on your first mortgage, you get a mortgage that’s thousands, tens of thousands, or even hundreds of thousands of dollars beyond what you still owe. This extra money is available by borrowing from the equity you’ve built up in your home by making monthly payments.
The difference between the original balance and the new loan amount is paid to you in cash. This is why it’s called a “cash-out refinance,” because it’s a great way to get a quick injection of accessible funds. The extra amount is now part of your new mortgage, so you will repay it with the usual monthly payments.
Here’s how it works. Say you want to remodel or renovate your home but need extra cash to complete all the additions and changes. You’ve been making steady loan payments each month for years and have built up quite a bit of equity in your home. A cash-out refinance can give you access to these funds, and most lenders will let you cash out up to 80 percent of your home equity.
When you use the additional funds on your cash-out refi to improve your financial situation, it can be a worthwhile move. For instance, if you make renovations with the cash, you are making material improvements to your home and increasing its value in the process. So when you want to sell your home, it can fetch a higher price. In this way, cash-out refinances can sometimes pay for themselves.
How Do You Get a Cash-Out Refinance?
Fundamentally, the process of getting a cash-out refinance is just like getting any other type of mortgage refi—and not that different from getting your original mortgage. Your lending institution will want to make sure that you can afford your new mortgage, so you should be prepared to come with proof of debt and income, a list of assets, identification, and the like.
For example, Solarity Credit Union requires refi applicants to bring the following:
- Current address
- Driver’s license and Social Security number
- Two months of bank statements
- Income history for the past two years
- Proof of income for the past 30 days
- List of current debts
Your lender will confirm your information is accurate and request an appraisal of your home. This process will help to prove that you can take on the extra financial burden and that the cash-out refinance can be a process that all parties materially benefit from in the end.
Modern lending institutions like Solarity often allow applicants to start the process online on their own or with the help of a qualified expert.
In the end, getting a cash-out refinance can be a perfect way to inject some liquidity into your portfolio, allowing you to do larger projects like renovating your home or starting a business. For this reason, if you’re looking for cash, you should talk to your local lending institution to see if a cash-out refinance is right for you, your family, and your finances.