What is a Cash Out Refinance? (2024)

If you have a significant amount of equity built up in your home and would like to convert that equity into money in your pocket, a cash out refinance may make sense for you.

Cash out refinance: How it works

  • A cash out refinance is a type of mortgage refinancing that allows you to access your home equity by borrowing more than you owe on your existing mortgage.
  • When you decide to do a cash out refinance, you take out a new mortgage that is larger than your existing mortgage and the difference between the two is provided to you in cash.
  • This type of refinancing can be a good option if you’re a homeowner who needs cash for home improvements, debt consolidation, or other large expenses.

Cash out refinance example

If your home is worth $300,000 and you owe $200,000, you have $100,000 in equity. With cash out refinancing, you could receive a portion of this equity in cash. If you wanted to take out $40,000 in cash, this amount would be added to the principal of your new home loan. In this example, the principal on your new mortgage after the cash out refinance would be $240,000.

The cash out refinance process

When you apply for a cash out refinance, you will need to provide documentation to verify your source of income, credit score, and other financial information. The lender will also appraise your property to determine its current value. Based on this information, the lender may offer you a new mortgage at a higher amount with a new interest rate.

Once you accept the offer of the new mortgage, the funds from the cash out refinance will be disbursed. You can use the cash for pretty much anything you choose, but it’s important to remember that the new mortgage will likely have a higher monthly payment and potentially a longer repayment term than your previous mortgage.

The amount of time it takes to complete the process will vary by lender. If you choose to apply with Discover® Home Loans, the timeline breaks down like this:

  1. Getting the basics (around 1-2 weeks). You’ll apply online or over the phone to review your loan options, then upload required documents. Discover will confirm your initial eligibility.
  2. Processing your info (around 4 weeks). We gather third-party information about your home and send your complete application to underwriting for a final decision.
  3. Closing your loan (around 1-2 weeks). We’ll contact you to schedule your loan closing and then arrange for funds to be sent to your accounts.

When is a cash out refinance a good option?

By refinancing your mortgage with a cash out option, you can borrow against the equity you have built up in your home to receive a lump sum in cash. While you are free to use the cash in just about any way you want, a cash out refinance is a good idea when you need to access your equity in your home to pay for large expenses such as home renovations, college tuition, medical bills, or elder care.

Another reason to consider a cash out refinance is to consolidate high-interest debt into a single, lower-interest mortgage payment. This can help you save money on interest and pay off debt from sources like credit cards or personal loans more quickly. In this situation, your new lender will most likely pay any of your previous lenders directly at the time of your loan closing.

A cash out refinance can also be a good idea if you want invest in a second home or assets such as rental properties or stocks. By accessing the equity in your home, you can free up cash to make these investments.

Drawbacks of a cash out refinance

While a cash out refinance can be an ideal choice in some situations, there are potential risks and disadvantages to consider. One risk is that a homeowner may end up owing more on a mortgage than the home is worth if housing prices decline. This can make it difficult to sell the home or refinance again in the future.

Another drawback is that a cash out refinance can extend the term of a mortgage, which can increase the total amount of interest paid over the life of the loan.

It’s also important to be cautious about using cash out refinancing or other long-term financing to pay for current or short-term expenses.

For example, if you use a cash out refinance to pay for a car that you’ll keep for six years, the interest rate could be much lower than the rate on a new car loan, but you might spend 24 additional years paying back the amount on the refinance loan.

If you use a cash out refinance to pay back credit card debt, you’ll have more credit available on the card, but remember that you still owe the same total amount plus anything else you might need to finance your closing costs.

Try using the cash out refinance calculator from Discover Home Loans to estimate how much equity you might be able to take out of your home and how you might reduce your payments by consolidating your existing debt.

What are alternatives to a cash out refinance?

If a cash out refinance doesn’t sound like the right type of loan for you, there are other options for borrowing money from the equity in your home.

Home equity loan

Another option for accessing the equity you’ve built in your home is to take out a home equity loan. While a cash out refinance replaces your current mortgage with new terms, a home equity loan can be an additional fixed rate loan.

Usually, a traditional cash out refinance has closing costs that can amount to hundreds or even thousands of dollars. If you choose Discover Home Loans as your lender, you don’t have to worry about these extra costs. We offer home equity loans and mortgage refinances with no appraisal fees, no origination fees, and no closing costs.

Home equity line of credit (HELOC)

A home equity line of credit (HELOC) more closely resembles revolving debt like a credit card.

Unlike a home equity loan that provides you with a lump sum when you are approved, a HELOC extends a line of credit from which you can withdraw funds as you need them. Any interest in the HELOC is based on the amount you withdraw, which can make it an attractive option for flexible withdrawals. Also, unlike a home equity loan, HELOCs typically use variable rates, which can fluctuate based on national economic factors. This can make your monthly payments change from month to month, which might make it more challenging to build a budget. Discover does not offer HELOCs.

Personal loans

Personal loans use your credit rating to earn an unsecured loan. Most unsecured personal loans will have higher interest rates and lower borrowing limits. Home equity loans, HELOCs, and cash out refinances are secured by using your home as collateral and can all typically offer lower rates than personal loans.

Closing thoughts: Cash out refinance

What is a Cash Out Refinance? (2024)

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