Cash-Out Refinance: How It Works and What to Know

With a cash-out refinance, you get a new home loan for more than you currently owe on your house. The difference between that new mortgage amount and the balance on your previous mortgage goes to you at closing in cash, which you can spend on home improvements, debt consolidation or other financial needs.

However, you'll now be repaying a larger loan with different terms, including a new mortgage rate, so it's important to weigh the pros and cons before committing to a cash-out refi.

With a standard rate-and-term refinance, you get a new interest rate or mortgage term without changing the balance of the loan. You might do this because rates have gone down, for example, and you want a lower monthly payment or because you need to add or remove a borrower.

In contrast, a cash-out refinance gives you a new loan that's larger than your current mortgage balance — and you pocket the difference.

How much cash you’re eligible to access depends upon your home equity — how much your home is worth compared to how much you owe.

• Determine your home equity. Home equity is the market value of your home minus what you still owe. For example, if your home is worth $300,000 and you have $100,000 remaining on your loan, you have $200,000 in home equity.

• Calculate the maximum loan you can take out. In general, that’s 80% of your home’s value. Using the previous example, you would multiply $300,000 times 0.80 for a maximum of $240,000. Remember that this isn’t the same as 80% of the purchase price; your home’s value may be different now than it was when you bought it. 

• Subtract your current mortgage balance. From that new $240,000 loan, you’ll have to pay off what you still owe on your home: $240,000 - $100,000 = $140,000.

• Estimate your total. In a cash-out refinance, you receive the difference between the balance on your previous mortgage and your new, larger mortgage. In this example, it's as much as $140,000. 

• Shop rates from multiple lenders. This will help you to get the best deal. 

• Weigh alternatives. Once you’ve researched available rates, calculate your new monthly mortgage payment and determine if it makes sense and is affordable for you. If not, you may be better off pursuing another type of loan. 

• Submit an application. As with your original mortgage, you’ll have to go through the appraisal and underwriting process before closing on the loan and accessing your cash. 

» MORE: See the best cash-out refinance lenders

In order to get a cash-out refi, you'll have to meet lender requirements. These can vary across lenders, so it's smart to shop around for the best interest rate.

But you'll likely need to meet these qualifications:

Debt-to-income ratio

Your DTI is your monthly debt payments, including your current mortgage, divided by your gross monthly income. For a cash-out refi, you'll usually need a DTI of 45% or less. If your DTI is over 45%, you may be required to have six months of reserves in the bank.

Credit score

You may qualify for a cash-out refinance with a score of 620, but a higher credit score will help you get a better interest rate.

Home equity

You'll usually need at least 20% equity in your home to qualify for a cash-out refinance. In other words, you'll need to have paid off at least 20% of the current appraised value of the house.

Seasoning requirement

With a conventional loan, you'll need to have owned the house for at least six months to qualify for a cash-out refinance, regardless of how much equity you have. Lenders might make an exception if you inherited the property or it was otherwise legally awarded to you.

VA loan borrowers must wait at least 210 days, while borrowers who have a loan backed by the Federal Housing Administration need to have lived in the home for at least 12 months before doing an FHA cash-out refinance.