Cash-out refinancing helps homeowners tap newfound home equity
Home values are higher now than during the peak of the 2000s housing bubble, and according to the National Bureau of Economic Research, there’s a good chance this boom may continue.
So now is a good time for homeowners to put their home equity to work with a cash-out refinance.
But before daydreaming about how a lump sum of cash could impact your financial goals, you should understand your cash-out refinance options as well as the benefits and eligibility standards for each. This will help you get the best rate when leveraging your home’s value.
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How a cash-out refinance works
A cash-out refinance is one in which a homeowner replaces their current mortgage with a bigger one. The difference between what is owed and what is borrowed goes back to the homeowner as a lump sum of cash.
As an example, say a homeowner owes $175,000 on a home and refinances their existing mortgage for a new loan amount of $200,000. This would be cash-out refinancing, netting the homeowner $25,000 of their home’s equity, less closing costs.
- Amount of money owed on loan: $175,000
- New loan: $200,000
- Cash-out: $25,000 (minus closing costs)
Generally, homeowners will do a cash-out refinance to tap into home equity without having to sell their home.
Cash-out refinancing can be used for a variety of purposes:
- Debt consolidation
- Home improvements
- Home renovations
- Vacation or travel
- Education expenses
- Paying off student loans or credit card debt repayment
- Investment purposes or building a nest egg
- Large purchases (i.e. automobile)
Lenders typically have no restrictions on how you can use cash-out funds.
Your best cash-out refinance options
While cash-out refinancing eligibility will vary by mortgage lender, the type of loan you are looking to refinance has its own rules and guidelines as well.
- FHA loans: borrow up to 80% of the value of your home
- VA loans: borrow up to 100% of the value of your home
- Conventional loans: borrow up to 80% of the value of your home
- Jumbo loans: borrow up to 70% of the value of your home
1. FHA cash-out refinance
FHA offers two different types of refinancing options: the FHA Streamline Refinance and cash-out.
Until 2009, the FHA allowed homeowners to cash-out up to 95% of their home’s value. The housing downturn spurred FHA guideline changes, however. As a result, there are now tighter underwriting requirements and reduced loan-to-value ratios (LTVs).
As of September 1, 2019, FHA cash-out refinances are limited to 80% of the home’s value.
In order to qualify for an FHA cash-out refinancing, your home had to have been your primary residence for the past 12 months.
You can do a cash-out refinance on your FHA loan if you’ve occupied your home for less than that, but you will be limited to the lesser of the original purchase price or current appraised value.
The FHA homeowner will also need to have a satisfactory payment history for the most recent 12 months, with no 30-day late payments.
The FHA has maximum loan amounts. These amounts vary by county.
2. VA cash-out refinance for U.S. military veterans
Just like any other mortgage loan, existing VA loans can be refinanced.
Similar to its FHA government counterpart, the VA offers two types of refinance loan options – a Streamline Refinance loan and a cash-out refinance.
The VA’s version of a streamline is also known as an IRRRL, or an Interest Rate Reduction Refinance Loan.
There are a few major differences between a VA streamline and a VA cash-out:
- A VA streamline allows no cash back, but a VA cash-out does
- A VA streamline does not require an appraisal; VA cash-out loans require a newly established value
- VA streamline loans don’t require income or asset documentation; cash-out loans do
For a VA cash-out refinance, the VA does not have a maximum loan amount. However, the VA does have a maximum amount that they will guarantee. As such, the maximum loan amount that most lenders will approve is equal to the conventional loan limit of $548,250.
There are exceptions to this rule if your home is in a “high cost” area, in which case loan amounts can rise to more than $822,375.
Mortgage lenders may allow loan amounts much larger, as long as a portion of equity is retained in the home.
The VA will allow a veteran homeowner to receive a loan up to 100% of their home’s value, assuming the loan is within maximum guarantee amounts. The new value is determined by a certified VA appraiser.
Shop around for a VA lender who offers 100% cash-out LTV refinances, as some lenders will limit veteran homeowners to just 90% of their home’s value.
The VA cash-out refinance remains one of the more attractive cash-out refinance options due to the high loan-to-value maximum, lack of monthly mortgage insurance, and lenient FICO score guidelines compared to other cash-out loan programs.
3. Conventional cash-out refinance
The conventional cash-out refinance is best for homeowners with more than 20% equity and good credit scores.
Fannie Mae and Freddie Mac set the rules for conventional cash-out refinances, as these are a subset of standard conventional loans.
If you’ve owned your home for a few years, chances are you qualify for the conventional cash-out refinance option.
In addition to lower interest rates, unlike government loans, conventional loans at 80% loan-to-value ratio will have no mortgage insurance or funding fees.
Sometimes, a conventional cash-out refinance can be the most advantageous option available.
Not only can you tap into the value of your home at a lower rate, for some, the loan may also rid them of unwanted FHA mortgage insurance.
This strategy has become increasingly popular as home values rise across the U.S.
However, this cash-out refinance option isn’t without some drawbacks.
You might pay a higher interest rate, and possibly higher fees. Cash-out refinance loans with high LTVs come with higher rates than no-cash-out loans.
Still, with lower rates still available, today’s borrowers are getting cash-out rates well below no-cash-out rates of just a few years ago.
The maximum loan amount for a conventional cash-out refinance is currently $548,250, and up to $822,375 in high-cost areas.
4. Jumbo cash-out refinance
A jumbo mortgage is a type of loan that doesn’t conform to Fannie Mae’s and Freddie Mac’s guidelines. Currently, any loan amount that exceeds Fannie Mae county loan limits is considered jumbo, or a non-conforming mortgage.
Jumbo mortgages became scarce after the housing crisis. Although more difficult to obtain, jumbo loans have begun to resurface.
Credit score requirements for cash-out refinance loans will vary from lender to lender, as will LTV limitations. Generally, you will need excellent credit, and stable employment to qualify for a jumbo loan. This applies even more so with a cash-out refinance on a jumbo.
Many banks will limit you to just 70% of your home value. There are a number of lenders, however, that now allow an LTV up to 80%.
Alternatively, there are some piggy-back refinance programs that help jumbo homeowners maximum their cash-out options, and obtain the best financing terms.
For example, some lenders are offering a 75/10/15 — the first mortgage is 75% of the home’s value, and a second mortgage is equal to 10%. Fifteen percent of the home equity remains.
Using this cash-out refinance option, jumbo homeowners could receive cash-out up to 85% of their home value.
Be sure to shop around with multiple mortgage lenders and compare your options for jumbo cash-out loans, as these can vary significantly.
Cash-out refinancing alternatives
Cash-out refinancing is a popular way for homeowners to access the equity they’ve built up in their homes, but there are drawbacks.
- Closing costs: A new mortgage loan means a round of underwriting fees, origination fees, appraisal fees, and nearly every other cost you encountered as a home buyer at closing (except, of course, a down payment or real estate agent commissions)
- Loan terms: Cash-out refinancing pays off your original mortgage and replaces it with a new one that will likely carry different loan terms. Your monthly mortgage payments are likely to change, and your new home loan may take longer to pay off
- Expensive loan: When your current loan is large, and the amount of money to cash out is not, a mortgage refinance could be an expensive way to borrow. A refinance calculator can help you determine whether a new loan is right for you
Luckily, just like there are cash-out refinance options, you also have cash-out refinance alternatives.
Home equity loan
Similar to cash-out refinancing, home equity loans also allow borrowers to leverage their home equity. But the two types of loans are fundamentally different.
A home equity loan is separate financing on top of your current mortgage balance. That’s why these loans are often called second mortgages.
A cash-out refi, though, replaces your existing loan entirely.
You can use the funds from a home equity loan to achieve any number of your financial goals including home renovations, real estate investments, or debt repayment. As with a cash-out refinance, there are no rules about what you can or can’t use the money for.
Home equity line of credit (HELOC)
Another option for borrowers who are looking for cash flow is a home equity line of credit, commonly referred to as an HELOC.
HELOCs are a revolving line of credit, kind of like a credit card, but which allow you to borrow money against the value of your home. Instead of receiving a one-time lump sum of cash, a HELOC allows homeowners to borrow money as personal finance needs arise.
This makes HELOCs a popular choice for emergency funds or for credit card debt repayment. Because unlike a new mortgage loan or personal loan, a home equity line of credit charges no interest debt on unused funds.
What are today’s cash-out refinance rates?
Cash-out refinancing can be ideal for homeowners seeking to tap into their home equity without selling their home.
With still-low mortgage rates and home values on the rise nationwide, now is a great time to consider your cash-out refinance options.