Homeowners refinance their mortgage loans for two main reasons. Some want a lower interest rate, something that will reduce their monthly mortgage payments. Others want access to cash they can use for home improvements, to fund their children's college education or to pay down high-interest-rate credit-card debt. To accomplish this second goal, homeowners will need to complete a cash-out refinance, refinancing for more than what they owe on their existing mortgage loans.
The key to a successful cash-out refinancing is equity. Owners must have enough equity in their homes to refinance to a mortgage loan that is higher than what they currently owe on their residence. As an example, homeowners owe $100,000 on a mortgage loan on a home worth $200,000. Because they have $100,000 worth of equity in the home, they have the freedom to take on a cash-out refinance. These owners might decide to refinance to a mortgage loan of $150,000. They take the difference between what they owe and the amount of their new loan in cash. In this example, the owner would receive $50,000 in cash, the difference between $150,000 and the $100,000 they owe on their home mortgage.
When you complete a cash-out refinance, there are no limits on how you can use these funds. Some homeowners might decide to use their money to pay off credit-card debt because credit-card debt comes at such a higher interest rate than does mortgage debt. Others might use their cash to improve their homes, putting in a new master bedroom or updating an old kitchen.
Lower Interest Rates
An added benefit of a cash-out refinance is that you'll often be able to lower the interest rate on your mortgage loan. This is one reason why homeowners might choose a cash-out refinance over a home equity loan. A home equity loan also provides homeowners with a lump sum of cash. But a home equity loan, as its name suggests, is a second loan, one that homeowners carry in addition to their existing loans. These loans often come with interest rates that are higher than are the ones associated with a cash-out refinance.
To qualify for a cash-out refinancing, homeowners will have to meet the same general requirements that come with a standard refinancing. Borrowers will need good credit scores -- most lenders reserve their lowest interest rates for borrowers with credit scores of 740 or higher -- low debt-to-income ratios and steady employment before qualifying for a refinance.
Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.