10/15/2020
How a cash-out refinance works
Like other refinance programs, a cash-out refinance replaces your existing home loan with a new one, typically at a lower interest rate.
The difference with a cash-out refinance is that your new loan will be for a larger sum than you currently owe on the home.
The difference between your current mortgage and your new one — the “extra” money you’re financing — is the amount you receive as a check at closing. That’s the cash out component.
Here’s an example of what a cash-out refinance might look like:
Current mortgage balance: $250,000
Refinanced loan balance: $280,000
Cash-out: $30,000 (minus closing costs)
Keep in mind that you can’t cash out all your equity using a cash-out refinance.
Lenders typically require the homeowner to leave at least 20% equity in their home, which limits the amount you can withdraw.
How much cash can I take out using a cash-out refi?
The amount you can cash out depends on your home’s value and your current loan balance.
The refinanced loan amount typically maxes out at 80% of the home’s value (though some VA cash-out loans allow up to 100% financing).
For example, if your home is worth $350,000, and you owe $250,000 on your mortgage, you have $100,000 in equity.
But you won’t be able to get a $100,000 check at closing.
First, a lender will calculate 80% of the home’s value — in this case, $280,000. That’s the maximum loan amount for your refinanced mortgage (also known as the ‘max LTV’).
When you refinance, the new loan (worth $280K) will first be used to pay off your existing loan.
The amount leftover, which in this case comes out to $30,000, is the most you can take out using a cash-out refinance.
But don’t forget about closing costs. If you have $5,000 in closing costs, your final check will be $25,000.
Advantages of cash-out refinancing
Refinance mortgage rates tend to be lower than the interest rates on other types of debt, so it's a very cost-effective way to borrow money. If you use the cash to pay off other debts such as credit cards or a home equity loan, you'll be lowering the interest rate you pay on that debt. Mortgage debt can also be repaid over a considerably longer period than other types of debt, up to 30
years, so it can make your payments more manageable if you have
a large amount of debt that must be repaid in 5-10 years. If market rates have dropped since you took out your mortgage, a cash-out refinance can let you borrow money and reduce your mortgage rate at the same time. Mortgage interest is generally tax deductible, so by rolling other debt into your mortgage you can deduct the interest paid on it up to certain limits, assuming that you itemize deductions. If you use the funds to buy, build or improve a home, you can deduct mortgage interest paid on loan principle up to $1 million for a couple ($500,000 single).
But if you use the proceeds from a cash-out refinance for other purposes, such as education expenses or paying off credit cards, the IRS treats it as a home equity loan, and you can only deduct the interest on the first $100,000 borrowed by a couple ($50,000 single). Contact us for a free quote today!
