With over $11 trillion in tappable equity currently available, a record number of homeowners can benefit from cash-out refinancing despite rising rates. This guide provides an in-depth look at how to strategically leverage home equity.
We’ll overview everything from the cash-out process and best uses to approval tips to make informed refinancing decisions during a shifting market.
How Does a Cash-Out Refinance Work?
A cash-out refinance involves taking out a new mortgage loan for more than what you currently owe on your home. By replacing your existing home loan with a higher principal amount at a lower rate, you can convert built-up home equity into usable cash.
The Process Step-By-Step
Here is how it works:
- You apply to refinance your current mortgage for more than the loan balance you owe
- The lender appraises your home’s current market value
- You qualify for a larger loan based on your home equity and finances
- At closing, your old mortgage gets paid off
- The difference between the two loan amounts gets issued to you as tax-free cash
- Current mortgage amount owed: $250,000
- Home current appraisal: $350,000
- New cash-out refinance: $300,000
- The cash you receive: $50,000
By tapping your equity, cash-out refis provide funds for consolidation, investments and other expenses as rates drop. But unlike traditional refinancing designed purely to decrease rates/terms, cash-out loans incur higher balances needing repayment.
Cash-out Refi vs Rate/Term Refi
The key difference versus a traditional “rate & term” refinance lies in increased principal. Rate/term refinancing simply renegotiates loan terms to improve payment savings but doesn’t provide actual cash.
Now that we have covered the basics, let’s weigh the major pros and cons.
The Pros and Cons of Cash-Out Refinancing
Cash-out refinancing offers borrowers flexibility unlocking equity for myriad uses in return for higher mortgage balances at lower rates. Weigh these key benefits and risks before proceeding:
Consolidate Higher Interest Debt
The top rationale – folding credit card, auto, student and personal debts into a lower mortgage rate through a lump paydown optimizes interest savings long run.
Access Cash for Home Renovations
Major remodels and upgrades can get financed directly into a new loan instead of higher interest alternatives like personal loans.
Fund Major Purchases
Six figure wedding costs, medical expenses, college tuition and more get spread over extended terms through your secured property.
Smooth Temporary Cash Gaps
Inject funds tiding you over during job changes or leaves preventing hurried asset sales at lower values.
Startup Business Ventures
Venture capital alternatives carry higher risk. Cash-out funds self-finance entrepreneurs through collateralized means.
Build Investment Seed Money
Secured property instead of overexposed market investments provides capital that may appreciation faster elsewhere long term at calculated risks.
Cash Burn on Deprecable Spending Financing near term consumption items risks burnt capital that brings no return – such as lavish vacations or vehicles.
Risks of Overspending Psychologically, accessible equity triggers many to overspend. Exhaust savings before tapping into illiquid home equity.
Repayment Burden Higher loan balances require budgeting more to interest and principal for the loan’s duration.
Closing Costs Closing out the existing mortgage and originating a new loan adds title fees, appraisal costs, and lender origination fees around 2-5% of the total borrowed amount.
Approval Challenges Default risks for lenders mean extensive qualification requirements beyond traditional refinancing, especially at higher LTVs.
With better context on the trade-offs involved, let’s explore ideal uses that make financial sense.
The Best Uses for Cash-Out Refinancing
Smart homeowners carefully consider their spending objectives before taking on 15-30 year debt. Analyze if alternative financing options better fit your timeline.
Then focus cash-out refi funds only on:
Repaying High Interest Credit Cards and Other Debt
Savings snowball rapidly folding 20%+ APR credit card balances into sub-6% mortgage rates. Accelerating paydown of student loans and personal debts also frees future cash flows faster.
Just beware convenience re-accumulating balances unless instilling financial disciplines first. Consider tracking software and set aside portions for rainy day funds to prevent vicious cycles re-emerging.
Funding Major Home Renovations
With housing demand still robust into 2023, renovations promise strong ROI that outweigh increased mortgage costs. The National Association of Realtors found most kitchen, bathroom and outdoor upgrades return 75-100% at sale.
Determine your planned tenure and research localized sweat equity opportunities before tapping. Set project contingency buffers too for unforeseen overruns that could risk going “underwater” before selling.
Starting a Business
Compare SBA loans, but cash-out invites self-financing new companies through one’s best collateral—a property that may appreciate with inflation. Preserve stocks and retirement accounts for rainy days. Treat tapped equity as risk capital and judiciously size it, assuming a zero return until profitability hits.
Managing Major Life Events
Finally secured capital cushions during volatile times like medical needs, educational costs or emergency costs. But also review alternatives like healthcare sharing ministries, work programs, scholarships and 0% balance transfer cards in tandem based on your situation uniqueness.
Alternative financing options always warrant consideration first before placing your property at risk.
Factors That Impact Cash-Out Refinancing Approval Odds
Qualifying for a cash-out refinance remains more stringent than standard “rate and term” refinancing. Underwriters scrutinize whether borrowers can repay higher principal balances. They examine:
Your Credit Score
Minimum scores range from 620-680. But 720+ scores fetch best terms and reduce scrutiny. Check scores six months ahead addressing any errors before applications.
Your Total Debt-to-Income Ratio
Lenders allow up to 50% DTI for conforming loans. But lower than 36% DTIs secure preferable rates given increased risk. Pay down revolving accounts during processing to skew favorably.
Your Loan-to-Value Ratio
Cash-out refinances fund up to 80% LTV on conventional loans and 85% for conforming programs. The more existing equity, the lower the risk profile for lenders.
Your Cash Reserves
Underwriters want liquidity cushioning changes in income spanning 6-12 months. Cash counts and so do stock/retirement accounts that borrowers can access penalties free if required.
Compile these key details before approaching lenders to smooth the application process.
Step-by-Step Process to Getting Approved
Navigating the process requires diligent coordination across various players – from home appraisers to insurance agents, title officers, loan processors and underwriters. Stay organized across these 7 steps:
1) Check If You Pre-Qualify
Calculator tools from lenders provide instant feedback on feasible amounts given home values and existing liens. Share details to see potential funding caps before formally applying.
2) Compare Lender Refinancing Rates
Shop options from big banks to mortgage brokers to credit unions and niche lenders. Compare total costs – rates plus origination/processing fees weighing grants or points paid to buy down rates.
3) Gather Required Financial Documentation
Expect providing 2 years tax returns, 30-60 days paystubs, 2 months bank/brokerage statements, breakdown of all assets, copy of current mortgage statement and authorization for credit checks.
4) Complete Full Written Mortgage Application
Formal disclosures, income proof requests, liability releases and permission to verify assets/credit get issued for signatures after initial talks.
5) Schedule Home Appraisal
An assigned inspector visits photographing interior/exteriors documenting property conditions while assessing fair market values to determine maximum loan amounts.
6) Get Final Underwriting Approval
An underwriter reviews all documents, credit checks, DTI calculations and appraisal against chosen loan product guidelines to issue final approve/deny decision.
7) Close on Your New Cash-Out Refinance!
Coordinate signing final revised disclosures and new mortgage documents. Funds disburse upon recording lien with county and overnighting signed originals to lender custodians. Celebrate and wisely invest your tap proceeds!
While every lender follows slightly different sequences, this captures key milestones to secure your new discounted financing and access earned liquidity.
Other Options Beyond Cash-Out Refinancing
Before committing property as collateral, weigh alternative financing options each with pros and cons. These include:
401k/IRA Loans – Tap retirement funds penalty free avoiding taxes. But risk losing market gains and payback upon job losses.
Personal Bank Loans – Unsecured products with higher rates and lower limits but less closing costs than mortgages. Easier income verification.
Pledged Asset Loans – Borrow against brokerage account balances/life insurance cash values. Rates competitive with mortgages without the lien risks.
HELOCs – Access equity through revolving credit lines vs term loans. Flexible draw down amounts but variable rates riskier long run.
Business Lines of Credit – Commercial products fund operations through ebbs/flows for entrepreneurs. Require business entity documentation.
Rewards Credit Cards – 0% introductory balance transfer options pause interest accrual short term. But benefits time out with disciplined paydown required.
Clarity on best financing alignment depends on your timeline, risk tolerance and capital dedication towards particular objectives. Just know alternatives exist.
Getting the Best Cash-Out Refinancing Rate in 2023
Current 30 year refinancing rates average around 6.5% as of late 2022 but lender margins vary:
Compare Multiple Lenders
Regional banks, credit unions and online lenders often beat large banks on loan fees and interest pricing.
Lock Discounted Rates Early
Protect against rises in securing commitments once the property gets appraised before final underwriting. Seek rate locks lasting 60+ days.
Negotiate Costs and Lender Credits
Push on origination fee discounts for large loan amounts. Request lenders buy down rates further through granting points/credits.
Buy Discounts Upfront By Paying Points
Paying one discount point (~1% of the loan amount) drops rates by ~0.25%. It is often worthwhile to stay for 5+ years, but break-even calculations matter.
With find text tips and diligent shopping, you can secure thousands in savings over the loan terms. Finding the right lender makes all the difference.
The money saved from properly leveraging cash-out refinancing often funds the closing fees over time. But research remains vital—consult mortgage brokers and run the math for your situation to determine if tapping into tax-free equity aligns with your near- and long-term financial objectives.