- Average Cost to Refinance a Mortgage & How to Save Money
- Costs to refinance a mortgage
- How are refinance costs determined?
- How to refinance with no closing costs
- How should I pay my refinance costs?
- Refinance closing cost FAQ
- What are today’s refinance rates?
- How refinancing your mortgage could put cash in your pocket
- How much can you save by refinancing your mortgage?
- When should you refinance your mortgage?
- Does a mortgage refinance make sense?
- How To Refinance Your Mortgage
- What is mortgage refinancing?
- The refinance clock is ticking
- Step 2: Check your credit score and history
- Step 3: Determine how much home equity you have
- Step 4: Shop multiple mortgage lenders
- Step 5: Be transparent about your finances
- Step 6: Prepare for the appraisal
- Step 7: Come to the closing with cash, if needed
- Step 8: Keep tabs on your loan
- Free up money each month
- Pay your home off faster
- Eliminate private mortgage insurance
- Tap your home’s equity
- Lock in a fixed-rate mortgage
- Refinancing isn’t free
- You may have a prepayment penalty
- Your total financing costs can increase
- Refinance vs. cash-out refinance: What’s the difference?
- Example of a no cash-out refinance (rate-and-term refinance)
- Example of a cash-out refinance
- Next steps: How to get the best refinance rate
- Learn more:
- Cash-Out Refinance Pros and Cons
- What is a cash-out refinance?
- Pros of a cash-out refinance
- Cons of a cash-out refi
- The bottom line
- A cash-out refinance helps you pocket money if your home has gained value since you bought it
- How a cash-out refinance works
- The pros of a cash-out refinance
- The cons of a cash-out refinance
Average Cost to Refinance a Mortgage & How to Save Money
Homeowners typically refinance to save money. Refinancing can result in a lower interest rate and monthly payment — and it could save you thousands over the life of your loan.
However, refinancing your mortgage isn’t free. The process involves paying closing costs again, which average between 2% and 5% of the loan amount.
The good news is refinance closing costs are negotiable. And it’s often possible to refi with no closing costs at all if you play your cards right. Here’s how.
Check your eligibility for a low- or no-cost refinance (Mar 25th, 2021)
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Costs to refinance a mortgage
Closing costs are lender and third-party fees you pay when getting a mortgage. You have to pay these on a refinance, just you did on your original mortgage.
Closing costs aren’t a flat fee, though. They vary depending on where you live, your loan amount, your lender, the loan program, whether you’re cashing out your home equity, and other factors.
Major closing costs (and estimated amounts) you’ll pay when refinancing a mortgage include:
- Loan origination fee — 1%-1.5% of the loan amount
- Discount points (optional) — 0%-1% of loan amount or more
- Application fee — $75-$300
- Credit check fee — $25
- Home appraisal fee — $500-$1,000+
- Title search and title insurance — $300-$2,000+
- Survey fee — $150-$400
- Attorney fees — $500-$1,000
- Recording fees — $25-$250 (depending on location)
- Processing and/or underwriting fee — $300-$900 each
- Prepaid taxes and homeowners insurance — varies
These are just the big-ticket items. You can see a full list of typical closing costs and amounts here.
The good news is that some closing costs are negotiable. You should always get multiple mortgage quotes from at least three lenders, including your current mortgage company, and compare your Loan Estimates to find the lowest-cost option.
You’re able to compare their fees and terms, which helps you save money. And if you find a lender with a cheaper loan origination fee, title search fee, application fee, or credit check fee, this sways the negotiating power in your favor.
You can refinance with the lender offering the lowest rate and fees at face value. Or you can use your offers as leverage for negotiation.
Your current lender might match the competitor’s fees or waive certain refinance costs to keep you as a customer.
Compare refinance rates and fees (Mar 25th, 2021)
How are refinance costs determined?
As a rule of thumb, closing costs are typically 2% to 5% of the loan amount.
If you’re refinancing a $200,000 mortgage loan, for example, you could expect to pay between $4,000 and $10,000 in closing costs.
But whether you’re on the high or low end of this range depends on several factors.
- Mortgage lender. Lenders charge different upfront fees, so some will have more expensive closing costs than others. You don’t have to refinance with your current lender; you should shop around for a lender with the lowest rate and fees for your new loan
- Interest rate. Your lender will charge prorated mortgage interest, starting from the date of closing to the first day of the following month. You’ll pay this upfront payment at closing, and your interest rate determines the exact amount
- Lender credits. Some lenders will extend borrowers ‘lender credits.’ This can eliminate the loan origination fee and potentially other closing costs, in exchange for the borrower paying a slightly higher interest rate. Receiving a lender credit can lower or even eliminate your upfront costs, but the higher rate will cost you more in the long run
- Discount points. Discount points or ‘mortgage points’ are the opposite of lender credits. This is an upfront fee you pay at closing to get a lower interest rate. Each discount point usually costs 1% of the loan balance and reduces your interest rate by about 0.25%. For example, if you pay two discount points on a $200,000 loan, you’ll pay an additional $4,000 in closing costs
- Location. Refinance closing costs include prepaid property taxes and insurance, just your original home loan. Your location will impact these amounts, especially the cost of your prepaid property taxes. But you really aren’t paying extra taxes and insurance to refinance — your current lender refunds any amount it holds in reserve
You might also pay more or less depending on your loan type.
For example, if you’re refinancing into an FHA home loan, which is a government loan backed by the Federal Housing Administration, you’ll pay an upfront mortgage insurance premium (UFMIP) equal to 1.75% of the loan amount. You can roll this fee into the loan or pay it upfront at closing.
VA loans and USDA loans have similar insurance charges (called the ‘funding fee’ and the ‘upfront guarantee fee,’ respectively), which can also be included in the loan amount.
Be mindful that cash-out refinances often involve higher closing costs since you’re increasing the total loan amount. A cash-out refinance is when you borrow cash from your home’s equity.
How to refinance with no closing costs
If you’re ready to refinance, you might ask: Can I refinance without paying closing costs?
This is an option, yet it’s important to understand the benefits and drawbacks of no-cost refinance methods.
Your lender might allow rolling your closing costs into your mortgage loan if you have enough equity in your home. The benefit of this approach is that you don’t pay anything upfront.
On the other hand, rolling the costs into the new mortgage increases your loan balance, meaning you’ll pay interest on this additional amount. This can result in paying thousands more over the life of the loan.
Be mindful, too, that rolling the costs into the loan is only an option with certain types of mortgages.
For example, a VA loan only allows borrowers to roll their funding fee into the loan. Similarly, an FHA refinance can only include the upfront mortgage insurance fee. Other closing costs must be paid upfront.
Another option is to ask for lender credits to avoid paying closing costs. This limits your out-of-pocket costs, but you’ll pay a higher mortgage rate in exchange.
Lender credits are typically better for homeowners who will only keep their new mortgage a few years. After that, the higher interest cost can start to outweigh the upfront savings.
If you plan to keep your refinanced loan long-term, rolling closing costs into the mortgage might make more sense.
Check your no-cost refinance options (Mar 25th, 2021)
How should I pay my refinance costs?
Take a close look at your financial situation when deciding the best way to pay your refinance closing costs.
If you have sufficient home equity, it might be worthwhile to include these costs in the mortgage and avoid an out-of-pocket expense.
This also makes sense when you don’t have much in cash reserves, or you don’t want to deplete your personal savings when refinancing.
However, since rolling the costs into the loan means a higher loan balance, a higher monthly mortgage payment, and higher interest charges, it might be better to pay your closing costs out-of-pocket and be done with it.
At the very least, you should try to pay your homeowners insurance and property tax reserves out-of-pocket. You’ll receive a check from your current lender for a similar amount a few weeks after closing.
Lenders hold a reserve account for necessary items but refund it to you when you refinance or pay off the loan. Because this is such a temporary cash outlay, it doesn’t make much sense to add that to your new loan balance.
However, if you want to raise some cash without doing a cash-out refinance, you could roll taxes and insurance reserves into the new loan and get a sizeable check weeks later from your current lender.
If you’re not sure which refinance option makes the most sense, your loan officer or mortgage broker can help you compare the upfront and long-term costs on a few different loans and help you decide.
Refinance closing cost FAQ
Why does refinancing cost so much?
Closing costs range from 2% to 5% of the loan amount and include lender and third-party fees.
Refinancing involves taking out a new loan to replace an old one, so you’ll repay many mortgage-related fees. These include the loan origination fee, appraisal fee, title search fee, application fee, and attorney fees.
You might also pay additional fees such as discount points to reduce your interest rate.
Is it cheaper to refinance with my current lender?
Sometimes it is cheaper to refinance with your current lender. It might reduce the cost of certain services, or waive certain fees to keep you as a customer.
Still, you should always shop around and get at least three mortgage refinance quotes from different lenders to compare costs, rates, and terms.
Another lender’s lower rate or fees might negate the savings you’re offered by your current mortgage company.
Can closing costs be included in a refinance loan?
Mortgage lenders sometimes allow borrowers to roll closing costs into their new mortgage loan. But keep in mind that rolling closing costs into the loan will increase the total loan amount. This is only an option when the homeowner has enough home equity that increasing the loan balance (and therefore the loan-to-value ratio, or LTV) won’t affect their refi eligibility.
Is it worth refinancing for 1%?
A 1% rate drop can often result in significant monthly savings and help you save on interest over the life of the loan. However, each homeowner’s situation is different.
Those with a small loan balance may not benefit, even with a 1% rate drop. But those with a large balance could save significantly with just a 0.25% drop.
You should evaluate your refinance options your current interest rate, new interest rate, loan balance, and overall financial situation.
Is an appraisal required when you refinance?
Most lenders will require an appraisal before refinancing. An appraisal determines a property’s value, and it’s necessary because lenders will not lend more than a home is worth.
The home’s value might have changed since you bought it, so a refinance appraisal determines the current market value.
However, FHA, VA, and USDA loans have Streamline Refinance options which often don’t require a new appraisal.
Is mortgage insurance required when you refinance?
You’ll need at least 20% equity to avoid private mortgage insurance (PMI) when refinancing. If you have a conventional loan and refinance with at least 20% equity, you will no longer have PMI.
If you have an FHA or USDA loan with at least 20% equity, you’ll need to refinance into a conventional loan to eliminate mortgage insurance, since these loan types always require it.
Only VA loans require no ongoing mortgage insurance, regardless of your down payment or home equity.
Is a credit check required when you refinance?
Lenders will check a borrower’s credit score and credit report to ensure they meet the minimum credit requirement for a loan program. Typically, you’ll need a minimum FICO score of 620 for a conventional loan, and a minimum of 580 for an FHA loan. The only exception is applying for a Streamline Refinance of your FHA, VA, or USDA loan. In this case, a credit pull might not be required.
When is refinancing a bad idea?
Refinancing might not be a good idea if your credit score needs improvement. If you’re not eligible for the best interest rates, the cost of refinancing might not be worth it. You might also hold off on refinancing if you don’t plan to keep the mortgage long. You typically want to keep the loan long enough to recoup what you paid in closing costs, unless you opt for a no-cost refi.
Does refinancing hurt your credit?
Lenders will check your credit report, and each inquiry can reduce your credit score by a few points. However, multiple inquiries from rate shopping only count as a single inquiry when completed within a 14- to 45-day window.
Keep in mind, too, that refinancing pays off and closes your old mortgage loan.
Some credit scoring models don’t factor in the history of closed loans when calculating scores, so your credit score might dip slightly after refinancing.
How can I save more money when I refinance?
Some homeowners can maximize their savings by refinancing into a different loan type or different loan term. For instance, homeowners with 20% equity can refi from an FHA loan to a conventional loan and eliminate PMI costs.
Refinancing from a 30-year term to a shorter term, a 15-year loan, could also net you a lower interest rate and big long-term savings. But your monthly payments would be higher.
Refinancing from an adjustable-rate mortgage to a fixed-rate mortgage could also help you save by locking in a lower interest rate for the long term.
What are today’s refinance rates?
Mortgage refinance rates are low across all loan types right now, including rate-and-term and cash-out refinances.
It’s a great time to lock in a low interest rate on your new loan, and many homeowners can choose to refinance with no closing costs.
Check your refinance options to see if a refi is worth it for you at today’s rates.
Verify your new rate (Mar 25th, 2021)
How refinancing your mortgage could put cash in your pocket
In addition to its impact on our health and wellbeing, the coronavirus has wreaked havoc on the American economy. With high unemployment and an uncertain future, many people are paying closer attention to their finances.
One result of the economic turmoil is that national mortgage rates have dropped to record lows. Depending on your current financial situation, now may be the best time to take advantage of low rates with a mortgage refinance.
The best place to start is with an online marketplace Credible, where you can quickly discover your mortgage refinance options by viewing available rates from multiple lenders. If the offers available are lower than your current mortgage interest, you may want to consider a mortgage refinance.
As you prepare to refinance your mortgage — and potentially save thousands over time — there are some things you should know about the process. Read on to learn more about how a mortgage refinance works and just how much cash you could be putting back in your pocket each month if you decide to go this route.
How much can you save by refinancing your mortgage?
A mortgage refi has the potential to save you thousands of dollars over the term of your loan. A difference of even one percent in your interest rate can result in significant savings. Here are some examples of just how much money you could save over the term of your home loan if you refinance today.
- If you have a $250,000 30-year mortgage with an interest rate of 3.875 percent, and you refinance it into a 30-year mortgage with an interest rate of 2.875 percent, you would reduce your payment by $138 a month and save more than $20,000 in interest, not including closing costs.
- If you refinance that same mortgage into a 15-year mortgage with an interest rate of 2.375 percent, you reduce your total interest by more than $96,000, and choosing a 10-year loan would save more than $112,000 in interest.
You could also save big by refinancing your mortgage — especially when interest rates are at record lows. To see just how much money you could save overall, visit Credible. Credible allows you to compare mortgage lenders and shows you prequalified rates within just minutes of inserting your information.
MORTGAGE RATES MATTER — HERE'S HOW MUCH JUST A 1% DIFFERENCE COULD MAKE
When should you refinance your mortgage?
You may want to consider getting a new loan if you’re currently required to pay private mortgage insurance (PMI). If you can refinance your home with a loan that is less than 80 percent of the value of your home, you could eliminate the PMI charge, which can be 0.5 to 1 percent of the loan. If your home has appreciated or you can put more money down, this may be a great step.
Also, consider how many months into your mortgage you already are. If your mortgage is just a year or two old, you won't impact your term significantly if you choose a loan with the same term.
But if you're 10 years into a 30-year mortgage, refinancing with another 30-year mortgage tacks 10 years onto your loan's length, erasing the headway you've made so far.
If you still want to refinance, choose a shorter term, such as 15- or 10-year loan.
Refinancing your mortgage can be a smart financial move as long as you understand all the consequences. Visiting Credible to compare rates can help you make your decision.
FED CUTS INTEREST RATES AGAIN — WHY YOU SHOULD REFINANCE DEBT NOW
No one knows how long the low rates will last and what the economy will bring. If you determine that refinancing is right for you, lock in low rates to save money and improve your budget in this uncertain time.
Does a mortgage refinance make sense?
While the savings can be significant, refinancing your mortgage only makes sense in certain conditions.
If you plan to stay in your current home for several years, it will probably make sense to refinance to take advantage of record-low rates.
But if you plan to move soon or there is a chance your employer could transfer you to a new location, refinancing might not be the right decision.
While you save money on interest, you will have to pay closing costs on the new loan, which typically costs about two percent of the amount borrowed.
On a $250,000 mortgage, this could be $5,000, and it could take months to recoup the savings in interest. Calculate your break-even point by dividing your closing costs by the monthly savings.
Then ask yourself if you will still be in your house that long.
WHAT ARE MORTGAGE ORIGINATION FEES?
For example, if refinancing your $250,000 mortgage saves $138 each month, it would take 37 months to recoup the $5,000 closing costs. If you plan to stay in your home longer than that, refinancing could make sense.
Keep in mind, converting your 30-year mortgage into one with a shorter term will increase your monthly payment. If your current job situation isn't secure, refinancing a loan with a shorter term could be a mistake. And if you’re self-employed or have been furloughed or laid off, you could find it harder to be approved.
How To Refinance Your Mortgage
With mortgage rates pushed to historic lows during the pandemic, it can make sense to refinance your loan. Here’s what you need to know about the process, and when it’s a good idea.
What is mortgage refinancing?
Refinancing a mortgage means you get a new home loan to replace your existing one, with the option to withdraw a portion of your home’s equity out as cash in the process. If you can refinance into a loan that has a lower interest rate than you’re currently paying, you could save money on your monthly payment and overall cost of the loan.
The best time to consider a mortgage refinance is when interest rates sink below the level they were when you closed on your original loan. As a rule of thumb, it’s worth considering a refinance if you can lower your interest rate by at least half a percentage point, and you’re planning to stay in your home for at least a few years.
Another good opportunity is when your credit improves to the point where you qualify for a new loan that has a lower interest rate.
There are a variety of reasons to refinance that can make financial sense, including:
- To reduce your monthly mortgage payment by securing a lower interest rate
- When the costs of refinancing can be recouped in a reasonable time period
- To get a shorter term, such as a 15-year loan to replace a 30-year mortgage, so you can pay it off faster and pay a lot less in total interest
- To switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan — a smart move if you think rates are going to go up in the future
- To extract cash from your home’s equity in a cash-out refinance
- To eliminate mortgage insurance if you’ve built up 20 percent equity in your home
Sign up for a Bankrate account to crunch the numbers with recommended mortgage and refinance calculators.
The refinance clock is ticking
Mortgage rates fell to all-time lows in late 2020 and early 2021. However, rates began edging up in February 2021. Mortgage experts expect rates to rise as the coronavirus vaccine is distributed and the U.S. economy returns to normal.
Mortgage rates probably won’t soar — the Federal Reserve has vowed to keep the rate it controls near-zero until further notice. The Fed doesn’t directly control mortgage rates, but its decisions do influence the mortgage market.
If mortgage rates do in fact follow the experts’ consensus, they’ll probably end up in the range of 3.5 percent by the end of 2021. In other words, the window to refinance is gradually tightening rather than slamming shut.
There should be a good reason why you’re refinancing, whether it’s to reduce your monthly payment, shorten the term of your loan or pull out equity for home repairs or debt repayment.
“Every situation is unique,” says Ann Thompson, Bank of America’s head of retail sales West. “Everyone has different priorities.”
What to consider: If you’re reducing your interest rate but restarting the clock on a 30-year mortgage, you may end up paying less every month, but more over the life of your loan. That’s because the bulk of your interest charges are in the early years of a mortgage.
Step 2: Check your credit score and history
You’ll need to qualify for a refinance just as you needed to get approval for your original home loan. The higher your credit score, the better refinance rates lenders will offer you — and the better your chances of underwriters approving your loan.
What to consider: It may make sense to spend a few months boosting your credit score before you start the refinancing process. Also, mortgage borrowers’ credit scores have risen to record highs as the pandemic made lenders stricter about extending credit.
Step 3: Determine how much home equity you have
Your home equity is the value of your home in excess of what you owe your mortgage lender on your loan. To figure it out, check your mortgage statement to see your current balance.
Then, check online home search sites or get a real estate agent to run an analysis to find the current estimated value of your home. Your home equity is the difference between the two.
For example, if you still owe $250,000 on your home, and it is worth $325,000, your home equity is $75,000.
What to consider: You may be able to refinance a conventional loan with as little as 5 percent equity, but you’ll get better rates and fewer fees if you have more than 20 percent equity. The more equity you have in your home, the less risky the loan is to the lender.
Step 4: Shop multiple mortgage lenders
Getting quotes from multiple mortgage lenders can save you thousands. Once you’ve chosen a lender, discuss when it’s best to lock in your rate so you won’t have to worry about rates climbing before your loan closes.
What to consider: In addition to comparing interest rates, pay attention to the cost of fees and whether they’ll be due upfront or rolled into your new mortgage. Lenders sometimes offer no-closing-cost refinances but charge a higher interest rate or add to the loan balance to compensate.
Step 5: Be transparent about your finances
Gather recent pay stubs, federal tax returns, bank statements and anything else your mortgage lender requests. Your lender will also look at your credit and net worth, so disclose your assets and liabilities upfront.
What to consider: Having your documentation ready before starting the refinancing process can make it go more smoothly.
Step 6: Prepare for the appraisal
Some mortgages lenders require a mortgage refinance appraisal to determine your home’s current market value for a refinance approval.
What to consider: You’ll pay a few hundred dollars for the appraisal. In addition, letting the lender know of any improvements or repairs you’ve made since purchasing your home could lead to a higher appraisal.
Step 7: Come to the closing with cash, if needed
The closing disclosure, as well as the loan estimate, will list how much money you need to pay pocket to close the mortgage.
What to consider: You might be able to finance those costs, which typically amount to a few thousand dollars, but you’ll ly pay more for it through a higher rate or loan amount.
Step 8: Keep tabs on your loan
Store copies of your closing paperwork in a safe location and set up autopayments to make sure you stay current on your mortgage. Many mortgage lenders will also give you a lower rate if you sign up for auto-payment.
What to consider: Your lender might resell your loan on the secondary market either immediately after closing or years later. That means you’ll owe mortgage payments to a different company, so keep an eye out for mail notifying you of any such changes.
Free up money each month
A rate-and-term refinance replaces your mortgage with a new loan that has a lower rate, meaning you have to pay less to your lender each month.
“There’s a significant opportunity to reduce your monthly cash requirements,” says Glenn Brunker, president of Ally Home. “Depending on the size of your mortgage, it could be $75 or $100 per month, or even several hundred dollars a month.”
Pay your home off faster
You may be able to refinance into a loan with a lower interest rate and a shorter term.
The savings in interest payments could be substantial, for example, if you’re able to refinance into a 15-year mortgage from a 30-year loan.
Still, if you’re putting more cash into paying off your mortgage, you may have less money on hand for expenses saving for retirement, college or an emergency fund.
Eliminate private mortgage insurance
If your original down payment was less than 20 percent, you have ly been paying private mortgage insurance, or PMI, an extra fee on every payment. If rising home values and your loan payments have pushed your home equity above 20 percent, you might be able to refinance into a new loan without PMI.
Tap your home’s equity
Homeowners with well over 20 percent equity in their home sometimes turn to cash-out refinancing.
That’s when you refinance your home loan into a new mortgage for a larger amount to meet a specific financial need and receive the difference in cash.
This may make sense if you’re considering using the money to invest back into your home through a major remodeling project or to pay off high-interest debt.
Lock in a fixed-rate mortgage
If you’re in an adjustable-rate mortgage (ARM) that’s about to reset and you believe that interest rates are going to rise, you can refinance into a fixed-rate loan. Your new rate might be higher than what you’re paying now, but you’re guaranteed it won’t rise in the future.
Refinancing isn’t free
Your refinanced mortgage comes with costs, such as an origination fee, an appraisal, title insurance, taxes and other fees, just your original mortgage.
Even if the refi results in a lower monthly payment, you won’t actually save money until the monthly savings offset the cost of refinancing.
You’ll need to do some math (use this calculator) to figure out how many months it will take to reach this break-even point. If there’s a chance you’re going to move before then, refinancing is probably not the best move.
You may have a prepayment penalty
Some mortgage lenders charge you extra for paying off your loan amount early. A high prepayment penalty could tip the balance in favor of sticking with your original mortgage.
Your total financing costs can increase
If you refinance to a new 30-year mortgage, you’re ly going to pay significantly more interest and fees over the life of your loan than if you’d kept the original mortgage.
Refinance vs. cash-out refinance: What’s the difference?
When you refinance in order to reset your interest rate or term, or to switch, say, from an ARM to a fixed-rate mortgage, that’s called a no cash-out refinance, or a rate-and-term refinance.
Rate-and-term refinancing pays off one loan with the proceeds from the new loan, using the same property as collateral.
This type of loan allows you to take advantage of lower interest rates or shorten the term of your mortgage to build equity more quickly.
By contrast, cash-out refinancing leaves you with more cash than you need to pay off your existing mortgage, closing costs, points and any mortgage liens. You can use the cash for any purpose. To be eligible for cash-out refinancing, you typically need to have substantially more than 20 percent equity in your home.
Example of a no cash-out refinance (rate-and-term refinance)
Jessica gets a $100,000 mortgage with an interest rate of 5.5 percent. Three years later, interest rates have fallen, and Jessica can refinance with an interest rate of 4 percent. After 36 on-time payments, she still owes about $95,700.
In this situation, Jessica can save more than $100 per month by refinancing and starting over with a 30-year loan. Or she can save $85 per month, while keeping the loan’s original payoff date, paying it off in 27 years, and also reducing the total cost of the loan by about $8,000.
Better still in terms of saving on interest would be to refi into a 15-year loan. The monthly payments will be higher, but the interest savings is massive.
Example of a cash-out refinance
Christopher and Andre owe $120,000 on a mortgage on a home that’s worth $200,000. That means that they have 40 percent, or $80,000, in equity. With a cash-out refinance, they could refinance for more than the $120,000 they owe.
For example, they could refinance for $150,000. With that, they could pay off the $120,000 on the current loan and have $30,000 cash to pay for home improvement and other expenses. That would leave them with $50,000, or 25 percent equity.
Next steps: How to get the best refinance rate
Once you’ve determined why you want to refinance and the type of loan you want, you’re ready to shop lenders and compare refinance rates. Get quotes from at least three mortgage lenders, including a mortgage broker, a bank and an online lender. Be sure to compare their rates as well as fees and other charges that could add to the overall cost of the loan.
Cash-Out Refinance Pros and Cons
Tap to learn how COVID-19 may affect refinancing
Due to the coronavirus pandemic, refinancing your mortgage may be a bit of a challenge. Lenders are dealing with high loan demand and staffing issues that may slow down the process.
Also, some lenders have increased their fees or temporarily suspended certain loan products. If you can’t pay your current home loan, refer to our mortgage assistance resource.
For the latest information on how to cope with financial stress during this pandemic, see NerdWallet’s financial guide to COVID-19.
What is a cash-out refinance?
A cash-out refinance replaces your existing mortgage with a new home loan for more than you owe on your house. The difference goes to you in cash and you can spend it on home improvements, debt consolidation or other financial needs. You must have equity built up in your house to use a cash-out refinance.
Traditional refinancing, in contrast, replaces your existing mortgage with a new one for the same balance. Here’s how a cash-out refinance works:
- Pays you part of the difference between the mortgage balance and the home’s value.
- Has slightly higher interest rates due to a higher loan amount.
- Limits cash-out amounts to 80% to 90% of your home’s equity.
In other words, you can’t pull out 100% of your home’s equity. If your home is valued at $200,000 and your mortgage balance is $100,000, you have $100,000 of equity in your home. You can refinance your $100,000 loan balance for $150,000, and receive $50,000 in cash at closing to pay for renovations.
Link your mortgage to NerdWallet to track your remaining balance and home value together.
Pros of a cash-out refinance
A cash-out refinance might give you a lower interest rate if you originally bought your home when mortgage rates were much higher. For example, if you bought in 2000, the average mortgage rate was about 9%. Today, it’s considerably lower. But if you only want to lock in a lower interest rate on your mortgage and don’t need the cash, regular refinancing makes more sense.
Debt consolidation: Using the money from a cash-out refinance to pay off high-interest credit cards could save you thousands of dollars in interest.
Higher credit score: Paying off your credit cards in full with a cash-out refinance can build your credit score by reducing your credit utilization ratio, the amount of available credit you’re using.
Tax deductions: The mortgage interest deduction may be available on a cash-out refinance if the money is used to buy, build or substantially improve your home.
» MORE: How and why to refinance your mortgage
Cons of a cash-out refi
Foreclosure risk: Because your home is the collateral for any kind of mortgage, you risk losing it if you can’t make the payments. If you’re doing a cash-out refinance to pay off credit card debt, you're paying off unsecured debt with secured debt, a move that's generally frowned upon because of the possibility of losing your home.
New terms: Your new mortgage will have different terms from your original loan. Double-check your interest rate and fees before you agree to the new terms.
“If you’re doing a cash-out refinance to pay off credit card debt, avoid running up your cards again.”
Closing costs: You’ll pay closing costs for a cash-out refinance, as you would with any refinance. Closing costs are typically 2% to 5% of the mortgage — that’s $4,000 to $10,000 for a $200,000 loan. Make sure your potential savings are worth the cost.
Private mortgage insurance: If you borrow more than 80% of your home’s value, you’ll have to pay for private mortgage insurance.
For example, if your home is valued at $200,000 and you refinance for more than $160,000, you’ll probably have to pay PMI. Private mortgage insurance typically costs from 0.55% to 2.
25% of your loan amount each year. PMI of 1% on a $180,000 mortgage would cost $1,800 per year.
Enabling bad habits: Using a cash-out refi to pay off your credit cards can backfire if you succumb to temptation and run up your credit card balances again.
» MORE: See current cash-out refi rates
The bottom line
A cash-out refinance can make sense if you can get a good interest rate on the new loan and have a sound use for the money.
But seeking a refinance to fund vacations or a new car isn’t a good idea, because you’ll have little to no return on your money.
On the other hand, using the money to fund a home renovation can rebuild the equity you’re taking out; using it to consolidate debt can put you on a sounder financial footing.
You’re using your home as collateral for a cash-out refinance, so it’s important to make payments on your new loan on time and in full.
A cash-out refinance helps you pocket money if your home has gained value since you bought it
If you need access to cash to reach big financial goals, there are plenty of ways to access money, such as using a credit card or taking out a personal loan.
And if your home's value has increased since you bought it, you could also access money through a cash-out refinance.
A cash-out refinance comes with lower rates than credit cards or personal loans. It also typically has a lower rate than a home equity loan or HELOC, which are alternative types of home loans for people whose homes have become more valuable.
How a cash-out refinance works
The amount you're allowed to receive in cash may depend on your lender, but as a general rule of thumb, you can't receive more than 80% of your home's value in cash. This way, you keep at least 20% of your equity in the home.
Let's say your home is valued at $200,000, and you have $100,000 left to pay on your initial mortgage. This means you have $100,000 in home equity, or 50% of the home value.
If you need to keep 20% of your equity in the home, then you're eligible to take out 30% of the value in cash, or $60,000.
You would take out a loan of $160,000 — that's $100,000 that you already owed on the home, and $60,000 in cash.
You'll still pay the additional costs that come with taking out a home loan, including appraisal fees, origination fees, and closing costs.
The pros of a cash-out refinance
- You could get a lower rate than you're paying now. Just with regular refinancing, you might be able to secure a lower interest rate when you use a cash-out refinance. The difference in rates will depend on when you bought your home, though.
If you bought the home when rates were high, you'll ly get a better rate now; if you took out your initial mortgage a few months ago, you might not see a significant difference.
- You'll get a lower rate than you would with a home equity loan or HELOC.
- You can choose between a fixed and variable rate. Home equity loans come with a fixed rate, and HELOCs usually have a variable rate. With a cash-out refinance, you can choose between a fixed or variable rate.
- You can use the cash for other goals. There are no rules for how you use the money from your cash-out refinance.
You may use it to pay off other debts, start a college fund for your children, or make home improvements, for example.
- You might get a tax deduction. If you use the money from your cash-out refinance to make improvements on your home, you may be able to deduct your mortgage payments from your taxes, according to the IRS Publication 936.
The cons of a cash-out refinance
- Your new loan comes with new terms. The new terms of your loan aren't automatically a con — they're just something to look out for. Make sure you understand the new terms of your loan upfront, including things your term length, interest rate, and monthly payments.
- You might have to get private mortgage insurance. Private mortgage insurance (PMI) is a type of insurance you have to pay if you've paid off less than 20% of your loan. When you bought the home, you may have been able to make a 20% down payment. Or you may have paid off at least 20% of your home value over the years, so you were able to cancel PMI. But if you borrow more than 80% of your home's value, then you'll have to pay PMI again. PMI can cost between 0.2% and 2% of your loan amount in a year. So if you borrow $160,000, you could pay between $320 and $3,200 annually.
- You'll ly pay more in fees than with a HELOC. HELOCs are known as low-fee options for tapping into your home equity. Some lenders don't require origination or closing fees for HELOCs.
- You could be risking foreclosure. If you can't make monthly mortgage payments, you risk your lender foreclosing on your home. Doing a cash-out refinance might result in higher monthly payments, private mortgage insurance, or a higher rate, which could make it harder to make payments. Before you take out cash, consider whether doing so will be a financial strain.