Your guide to your mortgage cash-out refinance

Did you know that your home equity may be one of your most valuable financial assets? It can help you fund a variety of personal goals. One way to access it is through a cash-out refinance.

This type of loan allows you to replace your mortgage and borrow additional funds for other needs, like a home renovation, household purchases or consolidating high-interest debt. Let's explore how it works, the benefit it offers and how it compares to other financing options.

What is a cash-out refinance?

A cash-out refinance is a mortgage refinance where you replace your current mortgage with a new, larger one, taking the difference as a lump sum of cash. The new loan will have a different interest rate or term. You can use the extra money, which is backed by the equity in your home, for other financial needs. A cash-out refinance differs from standard refinancing, where you only borrow what you need to pay off the loan balance.

Key benefits and strategic applications

A cash-out refinance provides a flexible way to borrow. It has advantages over other financing options, and you can use the additional funds for multiple types of expenses. Common uses often include:

• Debt consolidation: If you’re carrying a balance on two or more high-interest credit cards, you can consolidate that debt with a cash-out refinance. The rate is usually lower, and you'll consolidate multiple payments into a single monthly bill.
• Home improvements: You can access your home equity for a remodeling project, to add new space or to complete other upgrades. Smart projects not only make your home a better place to live, but they can also increase its value.
• Education funding: A cash-out refinance can help fund your education at a lower rate than a private student loan. It may be a valuable option if you've maxed out your federal loan limits. You can utilize the money you borrow for tuition, housing, books, supplies and other educational needs.
• Investment opportunities: Have you been thinking about starting your own business or investing in real estate? It’s typically easier to qualify for a cash-out refinance than a small business loan or commercial loan because it's backed by your home equity. There’s less risk to the lender since they don't have to rely on projected business revenue or future rental income. Keep in mind that investments are often risky, and your home is used to secure the loan. If the opportunity doesn't work out, you could face foreclosure if you’re unable to make the loan payments.
• Tax benefits: With a cash-out refinance, the money you borrow isn't taxable. It's a loan that you repay over time, so this could make it a better option than withdrawing from your retirement account. Early withdrawals may incur taxes and penalties.

How does a cash-out refinance work?

The application process for a cash-out refinance is the same as a new mortgage.

Let's say you want to refinance at a lower rate and take out additional funds to remodel your kitchen.

• Home value: $400,000
• Mortgage balance: $200,000
• Available equity: $200,000
• Amount needed for kitchen remodel: $50,000

1. Apply for a new mortgage

Your financial information will be reviewed to ensure you can repay the borrowed money.

2. Determine your LTV ratio

Lenders use the loan-to-value (LTV) ratio to measure loan risk, and they consider lower LTVs safer. Cash-out refinances are usually capped at 80% LTV, which means you must maintain at least 20% equity in your home.

The LTV ratio is calculated by dividing your new loan amount by your home's current value. Your new mortgage is for $250,000 (i.e., $200,000 balance + $50,000 for the kitchen remodel).

LTV ratio = $250,000 / $400,000 = 62.5%

This is well below the 80% cap, which means you have enough borrowable equity for the kitchen remodel.

3. Get your home appraised

Your lender will have your home appraised to determine the current market value and your equity.

4. Close on your new loan

Once the underwriting is complete, your lender will pay off your existing mortgage. You'll then receive the additional funds to use on your kitchen remodel project.

Cash-out refinance vs. HELOC, home equity loan and personal loan

Before you apply for a cash-out refinance, it's a good idea to assess your options. A HELOC, home equity loan or personal loan might be better suited for your needs. Here's how they compare.

Cash-out refinance

A cash-out refinance often makes sense when interest rates are lower than what you're paying and you're also borrowing for another need, like debt consolidation. You repay it over 15-30 years, and the closing costs are typically 2-5% of the loan amount. It usually has a lower rate than other loans, but you'll pay long-term interest on the extra cash you borrow.

HELOC

A home equity line of credit (HELOC) is worth considering when you don't know how much you'll need or you expect to borrow more than once, like with a home improvement project that you complete in stages. Because it's secured by the equity in your home, it usually has a lower interest rate than credit cards and personal loans, but not as low as a mortgage. You only pay interest on the amount you actually use.

With a HELOC, you can borrow as needed up to your limit, and repayment replenishes your available credit. The closing costs are typically lower than with a cash-out refinance. The biggest advantage of a HELOC is its flexibility — but it has a variable interest rate, which means your rate could increase in the future.

Home equity loan

A home equity loan lets you borrow a lump sum that's backed by your home equity, and you repay it with fixed monthly payments over 5-30 years. Interest rates are usually lower than those on personal loans or credit cards, with closing costs typically 2-5% of the loan amount.

This loan may be a good option when you know how much you need. The main advantage is that a home equity loan delivers predictable, low-interest financing. However, it's not as flexible as a HELOC because you receive the full amount upfront and start paying interest immediately.

Personal loan

A personal loan isn't backed by collateral and usually has a higher interest rate than a cash-out refinance, HELOC and home equity loan. You receive the full amount upfront and repay it over 3-7 years. There are no closing costs.

This loan is best for smaller amounts, especially when you don't want to use your home as collateral or have limited equity. Most lenders provide fast approvals, which makes it ideal for car repairs, unexpected medical bills and other urgent needs. The interest rate is usually higher than with secured loans.

Example of a cash-out refinance

A practical cash-out refinance example can help you see the benefits.

Let's say you own a home valued at $400,000 that you financed for $350,000. The mortgage payoff amount is $170,000, and you have $230,000 in home equity.

Rates have recently dropped, and you want to apply for a cash-out refinance to replace your mortgage. You also want to borrow an additional $30,000 to remodel your primary bathroom.

Current mortgage:

• Loan amount: $350,000
• Loan balance: $170,000
• Interest rate: 8.5%
• Term: 30 years
• Payment: $2,691.20

Your cash-out refinance application is approved, and you receive a new mortgage:

• Loan amount: $200,000 ($170,000 + $30,000)
• Interest rate: 6.25%
• Term: 30 years
• Payment: $1,231.43

With this new mortgage, you access $30,000 of your home equity and your payment decreases by $1,459.77 . The newly remodeled bathroom doesn't just look great, it could increase the value of your home by $20,000. If you later decide to sell, the updated bathroom will make your home more attractive to potential buyers.

Qualification requirements and eligibility

Lenders look at a variety of factors when they consider you for a cash-out refinance. Conventional, FHA and VA loans all have different qualification requirements.

• Credit score: A minimum credit score of 620 is typically required to qualify for a cash-out refinance with a conventional loan. FHA and VA loans have more flexible credit requirements.
• Debt-to-income ratio: Lenders use the debt-to-income (DTI) ratio to make sure you aren't taking on too much debt. It's calculated by dividing your current monthly debt payments by your gross monthly income, and the result is expressed as a percentage. Lenders usually prefer a DTI ratio of 43% or lower.
• Equity: Most lenders require that you maintain at least 20% equity in your home after borrowing with a cash-out refinance.
• Seasoning requirements: You must have at least 6-12 months of homeownership to qualify for a cash-out refinance.

The application process: Citizens' step-by-step guide

At Citizens, our cash-out refinance process is straightforward so you can get the funds you need without the hassle. Our dedicated team will guide you every step of the way, and most loans close within 30-45 days.

Here's what you can expect:

1. Determine your equity

Before you apply, estimate your home equity to see if you qualify for a cash-out refinance. Research recent sale prices of similar homes in your area to determine your home's current market value. Then subtract what you owe on your mortgage to determine your equity.

2. Gather your documents

Ensure you have the following documents to prevent delays:

• Social Security number
• Proof of income (pay stubs and W-2s)
• Bank statements
• Current mortgage information
• Government-issued ID

If you're self-employed, you may need additional documents to verify your income, like profit and loss statements and business bank statements.

3. Submit your application

Conveniently apply online, by phone or in person. If you're applying through our secure online platform, you'll be guided through the steps and can upload each document. Our loan specialists are just a phone call away if you have questions.

4. Home appraisal

Your home will be appraised to verify its value and confirm your equity. An independent appraiser will contact you to schedule an appointment. Both the interior and exterior are evaluated to assess your home's condition, additions, updates and any needed repairs.

If the appraisal is lower than expected, check the report for errors. Also, be sure to let the appraiser know if important information was overlooked.

5. Underwriting

Your financial information — your income, employment history, credit history, current mortgage details and monthly debts — will be reviewed. Missing or inaccurate information could delay the underwriting process, so be sure to respond quickly if you are contacted for clarification or additional documents.

6. Closing

Once approved, the closing appointment is scheduled. Carefully review all documents before signing. Your cash-out funds will be available a few days after closing.

Cash-out refinance FAQs

Here are answers to some commonly asked questions about cash-out refinancing.

Can you take equity out of your house without refinancing?

Yes, if you don't need to refinance, you can access your equity with a home equity loan or home equity line of credit (HELOC).

Do you pay taxes on a cash-out refinance?

No, the money you receive from a cash-out refinance is a loan that you repay. It's not taxable because it's not considered income.

How long does a cash-out refinance take?

With Citizens, the cash-out refinance process typically takes 30-45 days, from the application to the closing.

What credit score do you need for a cash-out refinance?

A minimum credit score of 620 is typically required to qualify.

Does a cash-out refinance affect my credit score?

A hard credit check will assess your ability to repay the loan. It may temporarily lower your score by a few points for several months.

Does a cash-out refinance require an appraisal?

Yes, your home will be appraised to determine its value and calculate your equity.

When a cash-out refinance just makes sense

A cash-out refinance is a smart way to tap into your equity and refinance your mortgage — but it's not ideal for every situation. Depending on your goals, a different type of loan might work better. Before you apply, consider your needs, loan options and the current interest rates.

It's also important to understand the potential risks that come with a cash-out refinance. Because your home equity serves as collateral, missed payments could lead to a foreclosure. Your monthly payments may increase, and the loan will reduce your available equity. If the housing market declines, your home's value could also drop, which would further reduce your equity or result in negative equity.

Borrowing responsibly can help you avoid financial problems later. To manage your risk, only borrow what you need and keep an emergency fund for unexpected expenses. Work with a trusted lender like Citizens to review your options and help you choose the best loan for your needs.