Last Updated: October 3, 2024

Cash-Out Refinance: What You Need to Know

A cash-out refinance allows homeowners to replace their current mortgage with a new one, while also borrowing additional funds based on the equity built up in the property. This strategy can provide access to cash for various purposes, such as home renovations, debt consolidation, or other large expenses.

Here’s what you can expect from a cash-out refinance:

1. Access to Home Equity

With a cash-out refinance, you can tap into the equity you’ve built in your home. Equity is the difference between what your home is worth and how much you still owe on your mortgage. 

For example, if your home is worth $300,000 and you owe $150,000, you have $150,000 in equity. A cash-out refinance allows you to convert a portion of this equity into cash while replacing your existing mortgage with a new one.

To apply for a home equity loan contact us, by calling 888-762-780. 

Requirements for a Home Equity Loan

To be eligible for a home equity loan, you typically need a FICO score of at least 660 but it can depend on each lender. Lenders also consider the following factors:

• Home Equity: The amount of equity you have in your property.
• Credit Score & History: Your overall creditworthiness.
• Debt-to-Income (DTI) Ratio: Your monthly debt payments compared to your income.
• Income History: Consistency and reliability of your income.

2. Higher Loan Amount

Since you’re taking out more money than you currently owe, your new loan will likely be higher than your previous mortgage. You can typically borrow up to 80% of your home’s value, but the exact amount varies depending on your lender, credit score, and market conditions.

3. Interest Rates and Loan Terms

A cash-out refinance typically comes with a new interest rate, which could be higher or lower than your original mortgage rate, depending on the current market. 

This new loan will also have different terms, which could extend your repayment period. While lower rates might save you money in the long run, extending your loan term may increase the total interest you pay over time.

4. Closing Costs

Just like your original mortgage, a cash-out refinance comes with closing costs. These fees usually range from 2% to 5% of the loan amount and can include appraisal fees, origination fees, and title insurance. Be prepared to either pay these costs upfront or roll them into your loan amount. 

5. Impact on Credit Score

When you apply for a cash-out refinance, your lender will perform a hard inquiry on your credit report, which can temporarily lower your credit score. Additionally, borrowing more money may affect your credit utilization ratio, a key factor in your overall credit score. However, responsibly managing the funds and making timely payments on your new loan can help improve your credit over time.

6. Purpose of the Cash

Many homeowners use cash-out refinances to fund home improvements or pay off high-interest debt, such as credit cards. However, it’s important to use this cash wisely since it increases your overall mortgage balance. Make sure the new loan payment fits into your budget, and avoid using the cash for unnecessary expenses.

7. Tax Considerations

The interest on a cash-out refinance may be tax-deductible, but this depends on how you use the cash. For example, if you use the funds for home improvements, the interest could be deductible. However, if you use the money for other expenses, such as paying off credit card debt, the interest may not be eligible for a tax deduction. Consult with a tax advisor to understand the potential tax benefits.

Here are some additional tax considerations:

1. Primary Residence vs. Investment Property: If you’re using a cash-out refinance on your primary residence, the interest might be deductible if you use the funds for home improvements. However, for an investment property, the rules differ, and you might be able to deduct the interest as a business expense.
2. Home Equity Loan Interest: The Tax Cuts and Jobs Act (TCJA) has changed the rules for deducting interest on home equity loans. Generally, interest on home equity debt is only deductible if used for purchasing, building, or substantially improving your home.
3. Capital Gains Tax: If you eventually sell your home after refinancing, be mindful of capital gains tax. The IRS allows a tax-free gain of up to $250,000 ($500,000 for married couples) if the home was your primary residence for at least two out of the last five years. However, if the cash-out refinance was used for non-home-related expenses, this could affect your taxable gains.
4. Mortgage Interest Deduction Limits: You can deduct interest on mortgages up to $750,000 ($375,000 if married filing separately) for loans taken out after December 15, 2017. For older loans, the limit is $1 million ($500,000 if married filing separately). Refinancing resets this limit, so consult a tax advisor to see how this might impact you.
5. Points Deduction: If you pay points on your cash-out refinance, they may be deductible. However, the deduction rules are different compared to an initial mortgage. Typically, points paid for a refinance must be deducted over the life of the loan, not all at once.
6. Alternative Minimum Tax (AMT): If you’re subject to AMT, some of the deductions related to your cash-out refinance may not apply. High-income earners should be particularly aware of this limitation.

Conclusion

A cash-out refinance can be a powerful financial tool, providing access to a large sum of money by tapping into your home’s equity. However, it’s crucial to weigh the benefits against the risks. Carefully consider how much equity you’re comfortable using and ensure that you can manage the new loan terms. When used strategically, a cash-out refinance can help you achieve your financial goals, but it’s important to proceed with caution.