By RMM Team
2023 Cash-Out Refinance Guide
Owning a home is a big investment and like with many long-term assets, it comes with a few added responsibilities. To keep your home appreciating in value and to make sure you continue to enjoy it, it's important to keep it maintained and updated.
However, completing necessary repairs or renovation projects don’t always come cheap. In fact, a little over a third of homeowners underestimate the costs of owning a home.1 What’s worse is that on average half of homeowners have had to pay for home improvement projects using higher-interest debt such as a credit card.
If funding your home improvement or repair costs is proving difficult,
a cash-out refinance might be the solution you need. Rather than chip away at savings or use high-interest debt, such as a personal loan or credit card, a cash-out refinance allows you to leverage available equity in your home to cover these necessary home costs. But a cash-out refinance isn’t only limited to home improvement projects. ReviewMyMortgage.com identifies several ways to take advantage of a cash-out refinance for purposes other than improving your home. If you have been considering remodeling a bathroom or revamping your kitchen, here is a quick review of how a cash-out refinance works, the advantages and disadvantages, and why now might be the right time to use one.
How Does a Cash-Out Refinance Work?
Anytime you refinance your mortgage, your lender pays off your existing loan, releases the old lien, and establishes a new lien against your property (for the new loan amount). If that sounds complicated, don’t worry. All the back-end processing is managed by your lender and the title company.
What is important is deciding which refinance option is best for you. Traditionally, there are two types of mortgage refinances: a no cash-out refinance (also sometimes referred to as a rate-and-term refinance) and a cash-out refinance.
Both refinance options consider what you owe on your home in proportion to its value (loan-to-value or LTV). The difference between all your outstanding mortgage balance (and any other junior liens) and your home’s value is your total available equity.
Typically, a no cash-out refinance is used to simply pay off your current outstanding mortgage balance (and sometimes refinance costs up to a limit). This leverage doesn’t typically leverage additional equity you have built up by paying down your mortgage or through your home’s appreciation. A no cash-out refinance is a great way to obtain better repayment terms for your mortgage
Conversely, a cash-out refinance is a type of mortgage refinance that does leverage accrued equity by paying off your outstanding mortgage balances with a higher loan amount and paying you the remainder in as lump sum cash distribution.
While your new mortgage payment can sometimes increase because you are taking out more money than what you currently owe, the net proceeds from a cash-out refinance can be put to work in a variety of ways.
How Much Equity Can You Access?
Lenders have different requirements for how much equity you can access with a cash-out refinance. The amount you could net after paying off your outstanding mortgages also depends on what your home is worth. Most lenders follow the conforming loan requirements set forth by Fannie Mae and Freddie Mac and will only allow you to access up to 80% of your home’s appraised value. Some non-conforming programs, including VA home loans, may allow you to access more equity (sometimes up to the full amount of what your home is worth). Other lenders might have different requirements.
Using ReviewMyMortgage.com’s comparison tool makes it easy to shop different financing solutions, allowing you to compare cash-out refinance options from multiple lenders so that you can maximize the amount of equity you can access.
Data reported by CoreLogic shows that nationally, homeowners had the largest average annual equity gain reported in over 11 years in the third quarter of 2021.2
What Can the Net Proceeds Be Used For?
The net proceeds you received from a cash-out refinance can be used in many ways. One of the most common uses is to pay for home improvement projects that will help you get more enjoyment out of your home and help it appreciate.
Remodel and renovation projects can sometimes cost thousands of dollars, which can really impact your savings if you are not careful. A cash-out refinance is a wonderful way to complete these projects without having to liquidate your hard-earned nest egg.
Other popular uses for net proceeds from a cash-out refinance include:
- Starting a new business
- Paying for college or other secondary education
- Funding retirement
- Investing in other ventures
- Purchasing additional real estate
- Consolidating high-interest debt
Pros and Cons of Using a Cash-Out Refinance
There are many advantages to choosing the option of going with a cash-out refinance. However, using a cash-out refinance doesn’t come without risk. It's important to weigh the advantages and disadvantages of any cash-out refinance before you commit to any financial decision.
The biggest advantage to a cash-out refinance is that it is flexible. Those that want to save money might choose to consolidate higher-interest debt. Others might decide they want to spruce up their kitchen or bathroom. If you're ambitious, you might even decide to finally pull the trigger on opening that small business.
The cherry on top of this sundae is that a cash-out refinance is often much cheaper than using other types of loans for the same purpose. First mortgage cash-out refinance loans often have lower interest rates compared to second mortgages, personal loans, and credit cards.
They are also considered to be less risky because they are secured by an asset, using your home as collateral. Using a cash-out refinance to consolidate debt may even help to improve your credit score.
While a cash-out refinance is a great option, there can be potential drawbacks to using one. For starters, completing a cash-out refinance is not free. Expect to pay closing costs, even if they are rolled into the loan amount or deducted from your total net proceeds. Similarly, most cash-out refinance transactions will require an appraisal. Not only does the appraisal come with a cost, but you also run the risk of your property value coming in lower than you anticipated which could shrink the amount of funds you might net. Furthermore, a cash-out refinance often means taking out more money than what you currently owe on your home. This can leave you more susceptible to market fluctuations. If the market takes a turn downward, you have a greater risk of being underwater (owing more than what your home is worth).
Is Now a Good Time to Complete a Cash-Out Refinance?
It's always important to explore all your options before you make a big financial commitment. ReviewMyMortgage.com makes it easy to compare multiple cash-out refinance solutions in your state so that you know you are getting the best deal.
There are many reasons that make now an opportune time to refinance. First, the current rate environment is ideal for any borrower. Even with anticipated rate hikes in 2022, mortgage interest rates are near historic lows, meaning you can lock in an excellent rate and save money in accrued interest over the life of your loan.
Another reason you might want to consider using a cash-out refinance now is that over the last few years homeowners have seen a starting increase in their available equity as the result of climbing home prices.
A recent report found that homeowners collectively gained about $2.9 trillion year-over-year since the second quarter of 2020.3 This could mean you are sitting on more equity than you had originally thought, allowing you to put it to work in other ways you may have been pushing off.
Lastly, as inflation continues to creep upward, it further erodes your purchasing power. The good news is that this makes a cash-out refinance look that much more attractive.
Over time, inflation can make it much more difficult to make large purchases or pay your bills. Why not battle inflation by paying off higher-interest debt now with a cash-out refinance? Using a cash-out refinance now can free up cash-flow and set yourself up to be more equipped to handle the ever-increasing cost of living.
1 Cinch Home Services. (2021, February 12). Survey: How Well Do Americans Anticipate the Costs of Homeownership? Retrieved January 12, 2022, from https://www.cinchhomeservices.com/view-blog/-/blogs/how-well-do-americans-anticipate-the-costs-of-homeownership
2 Boesel, M. (2021, December 09). Home Equity Gains Reached New Highs in 2021. Retrieved January 12, 2022, from https://www.corelogic.com/intelligence/home-equity-gains-reached-new-highs-in-2021/
3 CoreLogic, Media. (2021, September 23). Homeowners Gained $2.9 Trillion in Equity in Q2 2021, CoreLogic Reports [Press release]. Retrieved January 12, 2022, from https://www.corelogic.com/press-releases/homeowners-gained-2-9-trillion-in-equity-in-q2-2021-corelogic-reports/
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