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- A cash-out refinance lets you borrow against your home equity and put the cash toward other financial goals.
- Record-high mortgage rates have made cash-out refinancing expensive.
- Those considering a cash-out refinance may want to wait until rates drop later this year.
Mortgage rates are more than three percentage points higher now than when they hit historic lows in 2020 and 2021. As a result, fewer Americans are interested in refinancing.
However, homeowners are also sitting on a lot of equity right now, thanks to the breakneck home price growth that defined the pandemic housing market.
In Q1 2020, the median home price in the US was $329,000. By Q3 2022, that number had jumped to $454,900, according to data from the Census Bureau and the Department of Housing and Urban Development.
Because homeowners have gained so much value in the past couple of years, many are in a good spot to take advantage of their equity and use it to fund other financial goals, such as a home improvement or debt consolidation.
One of the most popular ways for homeowners to tap into their home equity is with a cash-out refinance. But refinancing means trading in your existing mortgage rate for a new one, and many borrowers have rates that are significantly lower than those currently available.
How does a cash-out refinance work?
Like a rate-and-term refinance, a cash-out refinance replaces your current mortgage with a new loan. With a cash-out refinance, however, you'll borrow more than what you currently owe on your mortgage and pocket the difference. In most cases, you can borrow up to 80% of your home's value. Here's an example of how that might work:
Your home is worth $300,000, and you still owe $150,000 on your mortgage. You decide to get a cash-out refinance for the full amount you can borrow, which is $240,000 (or 80% of $300,000). Once you've paid off your current mortgage, you'll be left with $90,000 (240,000 - 150,000 = 90,000), minus closing costs. Those leftover funds are yours to use as you wish.
When does a cash-out refinance make sense?
A cash-out refinance can be a good, low-interest way to access a large amount of cash. But it typically only makes sense to refinance your mortgage if you can get a lower rate than what you're currently paying.
To find out if a cash-out refinance makes sense for you, you'll need to compare the monthly and overall costs of your current mortgage to what a new mortgage would cost. If you can decrease your monthly mortgage payment and lower your long-term interest costs, the new mortgage could be worth it. However, don't forget to factor in closing costs.
Does it ever make sense to take on a higher rate to get a cash-out refinance?
Depending on your situation, getting a cash-out refinance that has a higher rate than your current mortgage could have some benefits, but it's important to consider all of the costs that come with this.
If your current monthly mortgage payment has your budget stretched too thin, refinancing into a longer term — even if it means taking on a higher rate — could lower your payment and give you some extra wiggle room each month. However, you'll pay more in interest over the life of the loan.
Additionally, if you need to access a large amount of cash, a cash-out refinance is often cheaper than other options, says Melissa Cohn, regional vice president of William Raveis Mortgage.
"Mortgage rates are significantly lower than credit card debt or other types of loans," Cohn says.
For example, while national mortgage rates are currently in the 6% to 7% range, many people pay as much as 20% in interest on credit card debt. And the lower your credit score, the higher your credit card interest rate could be.
"If you are looking to use the proceeds from a cash-out refinance in the near future for a home renovation, debt consolidation, or another life-changing event and don't expect to pay it off or pay it down materially in two to three years, fixed-rate mortgages allow you the peace of mind and reduce the impact on your monthly cash flow given you can amortize it over 30 years," says Sonu Mittal, head of mortgage at Citizens Bank.
An opportunity to refinance may come later this year
Mortgage rates have trended down somewhat in recent months, and most major forecasts expect mortgage rates to fall throughout 2023. The Mortgage Bankers Association, for example, expects 30-year fixed rates to drop to 5.2% by the end of this year.
Lower rates means that more homeowners will be able to get a better deal when getting a cash-out refinance. If you'd like to tap into your home's equity by refinancing, waiting a few months to see how rates trend could help you save money in the long term. Otherwise, you can consider other methods to access the money you have in your home.
Cash-out refinance alternatives
A cash-out refinance isn't the only way to take equity out of your home. Home equity loans and home equity lines of credit are two types of second mortgages that let you borrow against the money you have in your home without changing your existing mortgage. These loans typically come with higher interest rates, but the closing costs are often lower.
You may also find that an unsecured loan, such as a personal loan or credit card, works better for your situation. Though these also generally have higher interest rates, they come with the benefit of not tying your debt to your home. This means that if you default, you won't have to worry about losing your house.
Getting a cash-out refinance when mortgage rates are high typically doesn't make sense for most borrowers who are already locked into lower rates. While it can be a useful tool if you need to borrow a large amount of cash at a low interest rate, it's important to consider how it will impact your finances now and in the long term.