What is a cash-out refinance?
Did you know you can replace an old mortgage with a new one, even if the new mortgage has a larger amount owed than your existing loan? It’s known as cash-out refinancing and it’s used to help borrowers use the equity in their home mortgages to get some cash.
How does a cash-out refinance work?
- Find a lender who is willing to work with you. Submit any necessary paperwork to them.
- The lender will assess the previous terms of the loan, the balance to pay off the loan, and your credit profile.
- The lender makes you an offer after conducting an underwriting analysis.
- If you want to go ahead with the offer, you get a new loan that pays off your current loan and locks you into a new monthly payment plan.
You can also cash out refinance investment properties. It works the same way as refinancing a primary residence:
- Take out a new loan for the investment property’s value.
- Pay off the loan’s existing balance.
- The difference is yours to keep in cash.
- Use the cash for whatever you’d like, whether it’s to buy another investment property, make improvements to the property, or keep the cash on hand.
Cash-out refinance case study
Scarlette and her new husband, Akash, have been saving up to buy a home for a while. They’ve saved about $100,000. They take out a $400,000 mortgage to buy a $500,000 home. As the years go by, they don’t pay off the mortgage as quickly as they expected, and still owe about $400,000. The good news is that the market is strong and their property’s value has not dropped below the $500,000 they bought it for. They’ve also made a lot of improvements to the home and have earned $100,000 worth of home equity. Scarlette and Akash want to take advantage of the low-interest rates and refinance, so they speak to a lender and are approved for a new loan at 80% loan-to-value of their home’s current value ($600,000).
If you’re wondering why they would want to take out another $120,000 loan, it’s because they’re going to take advantage of cash-out refinancing and receive their equity in cash. They can choose to apply that cash to their current mortgage to owe less or they can use it to build more equity with improvements (maybe a kitchen reno) or even purchase an investment property.
The bottom line
Cash-out refinance is a technique used to help people get cash by getting a new mortgage that’s worth more than their previous mortgage balance, and getting the difference paid to them in cash. The catch is, people who deploy this strategy typically have to pay higher interest rates on their new cash-out mortgages. It’s up to the lender to determine how much cash someone receives based on their credit profile, bank standards, and their property’s loan-to-value ratio.