A cash-out refinance mortgage loan can help you consolidate debt, remodel your home, pay for college, make a large purchase, or even buy another property.
With this type of refinance, you convert home equity into cash by creating a new loan for a larger amount to cover these expenses. For this to be possible, the current value of your home must be greater than the amount owed on your existing mortgage.
Here’s how a cash-out refinance mortgage works
As an example, let’s say the Walkers want to remodel their home, which will cost $100,000. When they originally purchased the property, the couple borrowed $400,000. Today, they owe $200,000 on their mortgage, which means they’ve built up at least $200,000 in home equity. Over the years, property values have increased in their neighborhood, and their home is now valued at $500,000. The Walkers can convert a portion of their home equity into cash using a cash-out refinance.
In this example, the couple can take out a new mortgage loan for $300,000. The new mortgage would pay off the $200,000 remaining balance from their original loan and leave $100,000 available to pay for remodeling costs.
Cash-Out Refinance vs. HELOC
A cash-out refinance is just one way to borrow against your home’s available equity. A home equity line of credit, or HELOC, is another popular option. What’s the difference between the two? A cash-out refinance is a new mortgage that pays off your existing mortgage, so it may have different terms than the original loan. At closing, you receive the excess amount—the cash-out portion—as a lump sum.
A HELOC is a variable rate, revolving line of credit with its own terms and repayment schedule separate from your first mortgage. You can use your home equity line of credit as needed for a certain amount of time, called a draw period, which is typically 10 years. When you pay back the amount you used, it becomes available to you again.
Here are some other key differences between a cash-out refinance and a home equity line of credit
Cash-out refinance mortgage:
- Fixed or adjustable interest rates available
- One mortgage with one monthly payment
- A new mortgage with a higher loan amount using accumulated home equity
- Cash-out funds available at closing with payments spread out over a longer term
- May have a lower interest rate than home equity financing
Home equity line of credit:
- Variable interest rate connected to an index, typically the U.S. prime rate as published in The Wall Street Journal
- Interest rate changes as index rate changes
- Use funds as needed during 10-year draw period
- Revolving line of credit
- Flexible loan repayment options available
