Cash-Out Refinance: How It Works and What to Know

A cash-out refinance is a new home loan for more than what you currently owe on your house. This new loan pays off your original mortgage, and you pocket the extra cash. Since the cash is coming from your home, it’s best spent on home improvements, debt consolidation or other financial needs.

You’ll be paying a larger mortgage with different terms, including a new interest rate, so it's important to weigh the pros and cons before committing to a cash-out refi.

A cash-out refinance is different from a standard refinance, which changes your interest rate and mortgage terms without affecting the balance. With a cash-out refinance, you get a new mortgage for a larger amount, so that you can finance your home and other expenses with one loan.

How much cash you’re eligible to access depends upon your home equity — how much your home is worth compared to how much you owe.

• Determine your home equity. Home equity is the market value of your home minus what you still owe. For example, if your home is worth $300,000 and you have $100,000 remaining on your loan, you have $200,000 in home equity.

• Calculate the maximum loan you can take out. Lenders will usually allow you to borrow up to 80% of your home’s value. Using the previous example, you would multiply $300,000 times 0.80 for a maximum of $240,000. Remember that this isn’t the same as 80% of the purchase price; your home’s value may be different now than it was when you bought it. You can estimate your home’s value here. 

• Subtract your current mortgage balance. From that new $240,000 loan, you’ll have to pay off what you still owe on your home: $240,000 - $100,000 = $140,000.

• Estimate your total. In a cash-out refinance, you receive the difference between the balance on your previous mortgage and your new, larger mortgage. In this example, it's as much as $140,000. 

• Shop rates from multiple lenders. This will help you to get the best deal. 

• Weigh alternatives. Once you’ve researched available rates, calculate your new monthly mortgage payment and determine if it makes sense and is affordable for you. If not, you may be better off pursuing another type of loan. 

• Submit an application. You’ll have to go through the appraisal and underwriting process before closing on the loan and accessing your cash. 

In order to get a cash-out refi, you'll have to meet lender requirements. These can vary across lenders, so it's smart to shop around for the best interest rate.

You'll likely need to meet these qualifications:

Debt-to-income ratio

Your DTI is your monthly debt payments, including your current mortgage, divided by your gross monthly income. For a cash-out refi, you'll usually need a DTI of 43% or less. If your DTI is over 43%, you may be required to have six months of reserves in the bank.

Credit score

You may qualify for a cash-out refinance with a score of 620, but a higher credit score will help you get a better interest rate.

Home equity

You'll usually need at least 20% equity in your home to qualify for a cash-out refinance. In other words, you'll need to have paid off at least 20% of the current appraised value of the house.

Seasoning requirement

With a conventional loan, you'll need to have owned the house for at least 12 months to qualify for a cash-out refinance, regardless of how much equity you have.

VA loan borrowers must wait at least 210 days, while borrowers who have a loan backed by the Federal Housing Administration need to have made 12 months of on-time payments before doing an FHA cash-out refinance.