How Does a Cash-Out Mortgage Work?
Published July 22, 2022
A cash-out mortgage is a first lien designed to help homeowners access the equity in their property. Unlike a regular refinance, a cash-out option requires homeowners to borrow more funds than what they owe on a home. The difference is then delivered to the homeowner in a single lump sum. Cash-out refinancing can also help homeowners access lower interest rates and better loan terms, but this is often an auxiliary benefit.
If you’re interested in a cash-out refinance, let us know. We’d be happy to walk you through the process and explore your options.
A step-by-step guide to receiving a cash-out mortgage
Cash-out refinancing is slightly different than other types of home refinance. If you think this is the financial product for you, here are the steps you’ll need to complete:
Meet the requirements. Lenders set their own requirements for refinancing. In general, the requirements of a cash-out mortgage are slightly more difficult than those associated with regular refinancing. Your credit score should be around 600, your debt-to-income ratio should be less than 37%, and you should have a significant amount of equity in your home.
Understand what you need. If you meet the requirements of a cash-out refinance, understanding how much to take out is the next step. Work with a financial advisor or mortgage specialist to understand how much money you’ll need.
Apply for the mortgage. Each lender has their own process for cash-out refinance applications. At American Financing, your first step is to get pre-approved. Homeowners should be prepared to provide financial documents, like W-2s and bank statements, as well as other application materials.
Close on the mortgage. Keep in mind that cash-out mortgages have associated closing costs. These typically amount to 3-5% of the total loan amount.
Collect your check. After closing, your check will be delivered to your home in the mail. It should take between 3 and 5 days to arrive.
Related: How often can I refinance?
Common uses for cash-out mortgages
Most people use cash-out refinancing to fund specific projects, like a home repair or college education. We don’t typically recommend cash-out refinancing if you don’t have a clear use for the funds. Here are some of the most common uses of cash-out refinancing we’ve seen:
Debt donsolidation: Cash-out refinances are a great way to consolidate various sources of debt. This is especially useful for people with high-interest debts, like credit cards. Combining all debts into a single payment and single interest rate can help homeowners better manage their finances.
Education: Higher education is becoming increasingly expensive, and not all institutions accept federal financial aid. If you want to supplement a child’s education, a cash-out refinance can provide the funds you need.
Medical spending: Some homeowners have high medical costs. Using home equity can help fund essential procedures, like surgeries, cancer treatments, and childbirth. Additionally, a cash-out refinance can prevent individuals from taking on medical debt.
Investment property purchase: Some homeowners fund new home purchases with a cash-out mortgage. Depending on how much equity a homeowner has built up, a cash-out refinance can fund most or all of a down payment on a second home or investment property.
Understanding cash-out mortgage rates
Cash-out mortgage rates change frequently. But, when looking at long-term trends, rates typically hover around 5% or 6%. Keep in mind that 30-year cash-out refinance rates are likely to be slightly higher than the rates offered on an original mortgage. Lenders sometimes see cash-out refinances as a larger risk, as there is a higher chance of the homeowner defaulting on the loan. But, generally speaking, average 30-year fixed-rate cash-out refinancing is similar to rates available on original 30-year loans.
Refinancing homeowners also have the option to refinance into different loan terms and mortgage rates. For example, if you’re currently 15 years into a 30-year mortgage and want a cash-out refinance, you could refinance your cash-out mortgage at 15 years. This will result in a lower interest rate than those available with a 30-year cash-out refinance.
Related: Can You Cash Out a Second Mortgage?
Other cash-out options
A cash-out mortgage is not the only strategy homeowners have to access equity. A cash-out refinance is a great option for folks who want their funds delivered in a single lump sum. Cash-out refinancing also replaces the existing loan with a new mortgage, which means you’ll still have just one lien. If you want access to home equity but have different personal requirements, consider these options:
Home equity line of credit: A home equity line of credit, or HELOC, turns home equity into a revolving line of credit. A HELOC functions like a credit card, with the homeowner pulling funds out as needed and only paying interest on what they’ve used. HELOCs have draw periods and pay periods, but you’ll likely have several years of HELOC access before starting to pay the funds back. A HELOC is a great option for homeowners who have ongoing financial needs, like a kitchen renovation completed in stages.
Home equity loan: A home equity loan is a second lien, or a second mortgage. Similar to a cash-out refinance, the homeowner will receive their funds in a lump sum upon closing. However, because this is a second mortgage, a home equity loan usually has its own terms, including a different interest rate and a different term length.
Working with a lender you trust
Whether you’re interest in a cash-out mortgage or a different strategy to access equity, it is important to work with a lender you trust. If you’re curious about cash-out options, schedule an appointment with one of our dedicated mortgage consultants. We can review your finances to help you make an educated decision.
Not quite ready to start talking to a expert? We understand. If you’re still researching your options, consider any of the below resources. We also have a variety of mortgage calculators that can help you come to a more informed conclusion on your home refinance.