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How Does a Cash Out Refinance Work?

Taking cash out of your home means you may be able to consolidate debt, take a vacation, renovate your home, pay for college tuition, or even save for retirement. We can see those questions crawling up in your mind. How does a cash out refinance work? Is it meant for you? Is it the best option available? How does it compare to other options?

Read on to find the answers to all those and more pressing questions on the subject.

What is a mortgage refinance?

Mortgage refinance is replacing your initial mortgage with a new one that comes with better terms, like a new interest rate and different monthly payment requirements. When considering refinancing, you can choose between a rate and term refinance, and a cash out refinance.

What’s the difference between rate and term and cash out refinance? How does it differ from a home equity loan or home equity line of credit?

What we described above is a rate and term refinance. Alternatively, you could opt for a cash out refinance where your old mortgage will still be replaced but you can also borrow more cash. With this choice, you take out a loan that is larger than what you have left to pay while opting to receive the surplus in cash. Each of these options are categorized as a first mortgage.

Other methods of capitalizing on your home’s value are a home equity loan or home equity line of credit (HELOC) that let you borrow against the equity in your home and receive your funds in a single lump sum. These are considered a second mortgage, taken out in addition to your existing first mortgage with their own terms and repayment schedule. Both first and second mortgages fall under cash out refinancing.

Where does the cash come from?
A cash out refinance takes advantage of the equity you’ve built over time and gives you cash in exchange for taking on a larger mortgage. In other words, you borrow more than you owe on your mortgage and pocket the difference. The balance owed on your refinanced loan will equal the amount you owed on your old mortgage plus the amount borrowed, so the cash comes out of the loan that you’ll end up owing at payoff.

How does the appraisal and loan program guidelines affect how much cash you can take?

The amount you can take depends on many factors including how much of the original principal you’ve already paid off and your credit profile. A cash out refinance can get you an amount within your current home equity, which is the difference between the amount you currently owe on your mortgage and your home’s actual value. Cash outs are generally limited to about 80% of your home’s equity; you can never cash out 100%.

What can you use the cash for?
The extracted equity can be used for a variety of needs including:

  • Paying off the remaining balance of a first mortgage
  • Financing closing costs, points, prepaids, and real estate taxes of the new loan
  • Paying off an outstanding subordinate mortgage lien
  • Taking equity out of the property to use for other purposes like home improvement projects, emergency expenses, college tuition, or consolidating/paying off high interest credit card debt
  • Funding a short-term refinance mortgage loan combining a first mortgage and a non-purchase-money subordinate mortgage

When do you receive the cash and in typically what form?
It can take between 30 to 45 days to receive the cash after applying for the loan. This could be longer depending on the refinancing volume.

Bottom Line
Are you still asking yourself how does a cash refinance work? By this point, we hope not! Whatever your reasons for refinancing, the above should help you do the math carefully to ensure it will work for you. If you purchased a home a few years ago, you might benefit from a cash-out refinance now since interest rates are currently at historic lows. To make sure you’re making the most out of your options or to check if you qualify, speak with one of our MBA loan officers today to get more precise guidance.

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