Can You Borrow More Than You Owe When Refinancing?

Getting a lower interest rate is a major incentive to refinance, but tapping into your home's equity is another reason a refi can be attractive. If you've built up equity in your home and want to use that money for pressing needs, you might be able to borrow more than you owe when you refinance.

Equity refers to the amount of your home's value that isn't used as collateral for your debts, such as your mortgage or a home equity loan. As you pay down your mortgage, or your home's value increases, you build up equity in your home. For example, say you borrow $180,000 and your home is worth $200,000. At that point, you have $20,000 — or 10 percent — equity in your home because the home's value exceeds your mortgage by $20,000. If you pay down your mortgage to $160,000 and your home's value increases to $220,000, your equity is now $60,000.

Banks will limit how much of your equity you can cash out. According to the Lending Tree website, most lenders won't let you tap more than 75 percent of your home's value. For example, if your home is worth $200,000, 75 percent would put your maximum refinance at $150,000. So, if you've paid down your mortgage to $100,000, you could cash out as much as $50,000. However, if you've only paid down your mortgage to $140,000, you would be limited to cashing out $10,000.

When you do a cash-out refinance, the extra debt counts as home equity debt rather than home acquisition debt unless you use the extra cash to improve your home, like adding a porch or finishing your basement. The distinction matters when it comes to your taxes. You're allowed to deduct the interest on up to $1 million ($500,000 per spouse if married filing separately) in home acquisition debt; with home equity debt, you can only write off the interest on $100,000 — or $50,000 per spouse if married and filing separately.

If interest rates have risen or you won't qualify for a rate that's as good as you have on your original mortgage because your credit score has declined, consider using a home equity loan or home equity line of credit to tap your equity rather than a cash-out refinance. That way, you get to keep the lower interest rate on your original mortgage and still get to tap into your home equity. For example, say your current mortgage has a 3 percent interest rate, but you're only being offered 5 percent on a refinance. Instead of refinancing the entire mortgage, just take out a home equity loan for the amount you want to cash out.