If you want a way to increase your cash flow, you could take on a side hustle, look for a higher-paying job, or cut your spending. But what if you need money faster?
If you own a home, you could consider a cash-out refinance loan. The mortgage refinancing option could allow you to get tens of thousands of dollars from your equity. As with any other significant financial decision, such as taking out student loans, there are important things to consider about the process.
Here’s everything you need to know to decide if a cash-out refinance loan is a good option for you.
What is a cash-out refinance loan?
After the housing crash in 2008, people started looking at refinancing mortgages with low interest rates. But you might not have heard of cash-out refinance. So, what is it exactly?
A cash-out refinance is a type of mortgage refinance in which you take out a new loan to replace your current one. But the amount of the new loan will be higher than the balance you owe on the old mortgage, and you’ll receive the difference in cash. So, essentially, you convert some of your home equity into liquid funds.
To break down the math, let’s pretend you have a $250,000 home, owe $150,000 on the mortgage, and want $50,000 in cash flow. You’d take out a new loan for $200,000, which would pay off the $150,000 you owe and give you $50,000 in cash. Ideally, the cash-out refinance loan would have a lower interest rate than your current one.
You might consider taking this path if you need to fund a home renovation, which theoretically would increase the value of the house. Sometimes, people use the money for college tuition or to pay off student loans.
Cash-out refinance loan requirements
You must meet several requirements to be eligible for a cash-out refinance loan. These are three main criteria to consider.
1. Loan-to-value (LTV) ratio
To determine your LTV ratio, the lender views your current mortgage as a percentage of your home’s market value. So, the LTV ratio is your mortgage balance divided by the appraised home value.
Let’s say you have $75,000 left on your current mortgage and your home is valued at $100,000. The $75,000 would be divided by $100,000 to arrive at a 75% LTV ratio. Many lenders cap the maximum LTV ratio at 75%, according to Loan.com. So, you can get a loan for 75% of the current market value of your home, and you must have equity of more than 25%.
That’s why getting a home appraisal is an important step in the process. The value of your house is a key element in determining your LTV ratio. If you’re eying a cash-out refinance, be sure to repair anything that’s broken in your home and make updates to ensure the best appraisal.
2. Credit score
Your credit score can affect the interest rate on a cash-out refinance loan. Your home might meet the LTV ratio requirements, but if you have bad credit, your application could be denied or your interest rate could be high.
It typically wouldn’t make sense to take out a new loan on your home if the interest rate would be higher than your current mortgage rate. The goal is to keep your mortgage payments low while raising cash. If you’ll have to pay more in interest and therefore have a higher monthly payment, a cash-out refinance might not be a wise financial move.
3. Length of homeownership
To ensure you can afford the monthly mortgage, many lenders will require you to have made a year’s worth of payments on your current mortgage before applying for a cash-out refinance loan.
If you’ve lived in your home for less than a year and had it appraised before you got your mortgage, you’ll need to get a new appraisal. Then the lender likely will take the lower appraisal value to determine your loan amount.
Pros of a cash-out refinance
There are many pros and cons to keep in mind with a cash-out refinance loan. Here are some of the main benefits.
- It can cover major expenses: One of the biggest draws is the cash flow provided by the loan. You can get a huge chunk of money to help cover costs such as for investing in a new business or making home improvements. Or you could repay a large debt, such as an outstanding credit card bill, student loans, or unexpected medical expenses.
- Interest rate could be lower: By going the cash-out refinance route, you could secure a lower interest rate than if you took out personal loans to get the same influx of liquid cash.
- You could get a tax advantage: The entire interest on a cash-out refinance loan is tax deductible if you use the money to make home repairs or improvements. If you use the money for something else, the interest is tax-deductible only up to $50,000 for an individual or $100,000 for a couple. This would make a cash-out refinance a better option than credit card debt because that interest is not tax deductible.
Cons of a cash-out refinance
There are some downsides to a cash-out refinance loan to consider.
- There are hidden costs: As with any mortgage refinancing loan, you’ll have to pay closing costs and interest on the chunk of cash you get as well as on the cash-out refinance amount. In addition, you’ll have to pay a fee to have your home appraised for the LTV ratio. So you could pay up to thousands of dollars upfront in fees and costs, in addition to the thousands of dollars in interest you’d pay over the entire loan period.
- Your home could be at risk: Whenever you take out equity in your home, it puts the property in a risky situation if the value decreases. According to the July 2017 National Mortgage Risk Index, cash-out refinance loans are a major reason mortgages are at the same high risk of defaulting as they were during the 2008 housing crash. So, be sure you’re in good financial standing before making a risky move.
- Unsecured debt becomes secured debt: This is one of the biggest downsides to cash-out refinance loans. If you use the money to pay off credit card debt or student loans, you’d convert unsecured debt (no collateral required) into secured debt (collateral required). Your home would be the collateral in this case. If you can’t make the monthly payments on your new mortgage or end up filing for bankruptcy, the lender can foreclose on your house. Credit card debt, on the other hand, can be reduced or discharged in a bankruptcy. Student loans are hard to discharge in bankruptcy, but you won’t lose your home if you can’t pay.
Is a cash-out refinance loan your best option?
A cash-out refinance loan could be a good option if you need immediate cash flow for home improvements or need to pay down high-interest debt. You could get a better interest rate, too.
But if that’s not the case, you could land in a situation where you’re unable to pay the new loan and could lose your home. Or, you could end up paying more in interest over a longer period. You should never use a cash-out refinance loan to pay for nonessential things such as a vacation.
Alternative options for increasing your cash flow include getting a home equity line of credit, a home equity loan, or a reverse mortgage if you’re age 62 or older. If you’re dealing with high-interest debt, then you should consider debt consolidation companies.
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.16% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at time of application. The origination fee ranges from 1% to 6% and the average origination fee is 5.49% as of Q1 2017. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|7.73% – 29.99%||$1,000 - $50,000||Visit Upstart|
|6.26% – 14.87%1||$5,000 - $100,000||Visit SoFi|
|6.99% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|8.00% – 25.00%2||$5,000 - $35,000||Visit Payoff|
|4.99% – 29.99%3||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%4||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%5||$2,000 - $25,000||Visit LendingPoint|
|6.16% – 35.89%6||$1,000 - $40,000||Visit LendingClub|
|6.99% – 18.24%7||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%8||$2,000 - $35,000||Visit Avant|