A cash out refinance occurs when an investor takes out a new loan on an existing property to extract equity from that property. Cash out refinances happen when an investor refinances for more than the amount currently owed and receives the difference in cash. The cash is then used to invest in a new property or renovate an existing property.
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What Is a Cash Out Refinance?
A cash out refinance is a strategy where an investor refinances a home in order to extract equity from the property. The investor pays off the existing mortgage using the new loan and receives the difference in cash. Investors typically use a cash out refinance strategy to purchase a new investment property or make improvements on an existing investment property.
Cash out refinances are considered first mortgages. This is different from second-mortgage home equity loans, giving cash out refinances better interest rates and terms, on average. Further, cash out refinances can be done with an owner-occupied primary residence as well as with a non-owner-occupied investment property between 1 – 4 units.
We interviewed Heather McRae, Senior Loan Officer at Chicago Financial Services, who tells us that:
“Many investors also conduct a cash out refi with the intention of using the cash to purchase additional property, either all-cash or as a down payment for another mortgage. For investors looking to expand their portfolio this is a good way to do it.”
We also interviewed Randall Yates, President and CEO of The Lender’s Network, who says that:
“A cash out refi is a good option for investors who want to make upgrades or improvements on an investment property to increase the property’s value. This will allow an investor to sell the home for more or charge higher rent.”
Regardless of the purpose, a cash out refinance, also known as a “cash out refi,” can finance up to 75% of a property’s current fair market value (FMV), known as the loan-to-value (LTV) ratio. For example, a house worth $150,000 can be refinanced with a loan up to $112,500, derived as:
- ($150,000 fair market value) x (75% LTV) = $112,500 maximum refinance amount
Investors with existing mortgage balances below $112,500 can use the new loan to pay off the existing mortgage and use the difference to put a down payment on a new investment property or make improvements on an existing investment property.
Cash out refinances are only beneficial if an investor has significant equity in a current property. This is because the difference between the existing mortgage balance and the new loan amount is what an investor pockets in cash and uses to fund other investments. A rule of thumb is that an investor should have at least 30% – 40% in equity prior to executing a cash out refinance.
Therefore, the three important components of a cash out refinance are:
- The existing mortgage balance
- The property’s fair market value
- The new loan amount
Who Is a Cash Out Refinance Right For?
A cash out refinance is typically used by investors who have equity in an existing home or investment property. These investors use a cash out refinance to extract their equity and purchase either a new investment property or renovate an existing investment property. The because the new loan amount is above the old mortgage balance and the difference is pocketed in cash.
Specifically, a cash out refinance is right for three types of investors:
- Short-term fix-and-flippers looking to purchase, renovate, and flip a new investment property.
- Long-term buy-and-hold investors looking to put a down payment on a new property or purchase it with all-cash.
- Long-term buy-and-hold investors looking to renovate an existing rental property.
This is because lenders don’t care what an investor does with the excess capital after refinancing and paying off their existing mortgage. All a lender cares about is the refinanced property and an investor’s ability to repay the loan. There are no restrictions on how an investor uses the cash from a cash out refinance.
Therefore, the money earned on a cash out refi can be used to renovate an existing rental property in an attempt to increase its value and its rental income. It can also be used to finance a short-term fix-and-flip project as well as a long-term rental property. The funds can also make it easier to compete with all-cash buyers for foreclosures or properties sold at real estate auctions.
Investors who use a cash out refi to purchase a rental property or fix-and-flip project will often use the cash to cover the down payment on a hard money loan or conforming mortgage. National hard money lenders such as LendingHome offer short-term hard money loans. National mortgage lenders such as Rocket Mortgage offer long-term conforming mortgages.
Regardless of intention, investors need an existing long-term property in order to execute a cash out refi. Further, cash out refinancing is only effective if an investor has the following:
- 30% – 40% equity in an existing property: either an owner-occupied primary residence or a non-owner-occupied investment property
- 640+ credit score (check your credit score for free here)
- 36% – 45% Debt-to-Income Ratio
- 0 – 6 Months Cash Reserves
Borrowers who don’t meet these requirements will be unable to execute a cash out refinance.
Let’s take a minute and look at a general example of a cash out refinance and why it’s beneficial for investors.
Example of a Cash Out Refinance
Investors can refinance their primary residence as well as any investment properties they already own. The terms and mechanics of a cash out refinance is the same for each. Further, it’s the same regardless of what an investor intends to do with the additional capital after refinancing.
Investors start by assessing the difference between an existing property’s fair market value (FMV) and its existing loan balance. If there is at least a 30% – 40% difference, it might make sense to execute a cash out refinance.
For example, an investor might want additional capital to either make improvements on an existing property or to purchase a new property. Paying for an independent appraisal and looking at the value and mortgage balance of an existing investment property, the investor finds the following:
- $150,000 fair market value (FMV)
- $90,000 remaining mortgage balance
The investor knows that he has 40% in equity and is a good candidate for a cash out refi, derived as:
- ($150,000 – $90,000) / ($150,000) = 40%
From there, the investor refinances the investment property with a new loan at a 75% loan-to-value (LTV) ratio. This means that the investor will receive $112,500 in cash from a title or escrow company, found as:
- ($150,000 FMV) x (75% LTV) = $112,500
The funds are typically wired directly into the borrower’s bank account within 3 days of loan approval. The investor then takes the money from the refinance and completely pays off the old mortgage, leaving him or her with $22,500 in cash. This is derived as:
- ($112,500 new loan amount) – ($90,000 old mortgage balance) = $22,500
The cash is typically used to either make improvements on an existing property or as a down payment to purchase a new investment property. As part of the cash out refinance, borrowers will typically have to cover the following expenses:
- 2% – 5% closing costs
- 0% – 3% loan origination fees
These fees are taken directly out of the loan, reducing the total loan amount by as much as 8%. With 2% in closing costs and 1% in loan origination fees, for example, the loan amount is reduced to:
- ($112,500 loan amount) – ($112,500 x 2% closing costs) – ($112,500 x 1% origination fees) = $109,125 loan amount
This reduces the amount of cash that an investor receives to:
- ($109,125 loan amount) – ($90,000 old mortgage balance) = $19,125
At the end of this cash out refi, the investor will have $19,125 in cash to invest in other real estate assets or renovations. Further, assuming the term is the same, an investor will typically have a slightly lower interest rate and a slightly higher down payment, causing the new monthly loan payment to be less than the old monthly mortgage payment.
We discuss the specific costs, terms, and qualifications of a cash out refi in the section below.
Cash Out Refinance vs. Home Equity Loans
A home equity loan is a second mortgage taken out on a home in order to pay for large items such as education, home improvements, medical bills, or something similar. There are two types of home equity loans:
- Home Equity Loan (HEL) – One-time lump sum loan paid back over a specific amount of time.
- Home Equity Line of Credit (HELOC) – Revolving credit line based on the value of a home.
However, while a HEL or HELOC are good options for owner-occupied primary residences, they’re not suitable for investors. As Heather McRae warns us:
“It’s very difficult to find banks who will provide a home equity line of credit on an investment property. Many second mortgage companies got burned in the mortgage crisis. When people get into trouble financially, they will stop making payments on their investment properties before their primary residence.”
Further, a cash out refinance will typically have a lower interest rate and a longer term than a home equity loan or line of credit. We recommend that investors explore their cash out refinance options first before looking into HELs and HELOCs.
Still, there might a few occasions when a home equity loan is a good alternative to a cash out refi. Since HELOCs are lines of credit, for example, short-term fix-and-flippers can take out a HELOC and wait to use it when the opportunity arises. This isn’t possible with a cash out refi or a HEL, both of which issue a lump sum amount and charge fixed monthly payments.
If you’re interested in more information on home equity loans, check out our article on when to use a home equity loan or line of credit. If you own multiple investment properties and are interested in accessing the equity in all of them with a single loan, read our article on blanket mortgages. For more information on the costs, rates, terms, and qualifications of a cash out refi, read the section below.
Cash Out Refinance Rates, Terms & Qualifications
The new loan obtained in a cash out refinance is typically similar to the old mortgage. The differences are that the new loan will usually have a lower interest rate and a lower loan-to-value ratio. Let’s take a moment to discuss the specific rates, terms, and qualifications of a cash out refi in more depth:
|Cash Out Refinance|
|Loan Amount||Up to 75% Loan-to-Value (LTV)|
|Interest Rate||2.99% - 5%|
|Fees||0% - 3% Lender Fees
2% - 5% Closing Costs
|Loan Term||15 - 30 Years|
|Time to Funding||30 - 45 Days|
|Qualifications||640 Minimum Credit Score
(Check your credit score for free here)
36% - 45% Debt-to-Income Ratio
0 - 6 Months Cash Reserves
1. Cash Out Refinance Loan Amount
The maximum loan amount allowed on a cash out refinance is regulated by Fannie Mae. Loan amounts are issued as a percentage of a property’s fair market value (FMV), known as the loan-to-value ratio. According to Fannie Mae, the maximum loan amount for a cash out refinance is as follows:
- 1 Unit Property: 75% LTV
- 2 – 4 Unit Property: 70% LTV
Further, if a property was listed for sale during the last 6 months, Fannie Mae sets a maximum loan amount of 70% LTV, regardless of the number of units.
2. Cash Out Refinance Interest Rate and Costs
One of the benefits of a cash out refinance is that the interest rates on the new loan are typically lower than the interest rates on the old mortgage. Interest rates can be either fixed and variable and are generally between:
- 2.99% – 5%
This is lower than the 4% – 6% rates found on a traditional mortgage or the ~5% found on a home equity loan or line of credit.
However, since cash out refis are unique, the loan origination fees charged are typically higher than with a traditional mortgage. What’s more, unlike a home equity loan, cash out refis require that the borrower pays additional closing costs.
Therefore, the costs associated with a cash out refinance include:
- 0% – 3% Lender Fees
- 2% – 5% Closing Costs
These costs and fees are taken directly out of the new loan, reducing the lump sum amount received by the borrower.
3. Cash Out Refinance Loan Term
The typical loan term of a cash out refinance is between 15 – 30 years. This is important to note because a cash out refinance will typically extend the loan term beyond an investor’s old mortgage. It’s common for investors with as little as 8 – 10 years left on their existing mortgage to refinance to a 30-year loan.
Loans on a cash out refinance generally take between 30 – 45 days for approval. Once approved, the cash is wired to the borrower by a title or escrow company within 3 days. It’s up to the borrower to repay the old mortgage in full.
4. Cash Out Refinance Qualifications
Fannie Mae sets specific qualifications for a cash out refinance. Specifically, investors are required to have the following minimum requirements for approval:
- 640 minimum credit score (check your credit score for free here)
- 36% – 45% debt-to-income ratio
- 0 – 6 months cash reserves
The lower the credit score the higher the required debt-to-income ratio and higher the required cash reserves. The opposite is also true. This is because cash out refis for investment properties are risky for lenders.
Further, Fannie Mae also requires the following:
- Property cannot be listed for sale at time of loan application
- Property is not eligible if it was purchased in the last 6 months
However, an investment property that was purchased in the last 6 months is eligible for a cash out refi if it meets the delayed financing rule. The delayed financing rule requires that an investment property has:
- Loan amount that’s less than the original purchase price plus closing costs
- “Arm’s-length” transaction, meaning that there was no prior relationship between the buyer and seller
- Final closing disclosure showing the financial details of the transaction
If these provisions are met, an investor can refinance an investment property within 6 months of the purchase.
Investors should also follow the following rule of thumb when looking for a cash out refi:
- 30% – 40% equity in an existing property: owner-occupied primary residence or a non-owner-occupied investment property
This is because the loan obtained through a cash out refinance cannot be more than 75% of the property’s fair market value (FMV).
Finally, Randall Yates, President and CEO of The Lender’s Network warns us that:
“It’s more difficult to get approved for a cash out refi on an investment property than for borrowers looking to refinance their primary residence. This is because it’s more of a risk for a lender to lend money to an individual who is not occupying the property.”
To help circumvent this problem, investors should have the following prior to applying for a cash out refi on an existing investment property:
- 6 months cash reserves
- 2 years personal tax returns
- Current rental lease agreement showing a 1.25 debt service coverage ratio (DSCR)
If an investor is able to provide a lender with these items, along with a minimum 640 credit score and a maximum 45% debt-to-income ratio, then a cash out refi is possible.
How to Apply for a Cash Out Refinance
Most traditional mortgage lenders offer cash out refinance options. Online mortgage lenders such as Quicken Loans, for example, are great options for investors looking for a cash out refi.
Regardless of the lender, the application process for a cash out refinance is fairly standardized. Borrowers should expect to follow these five steps:
- Determine Amount of Equity – The first step as an investor is to determine the amount of equity you have in a potential cash out refinance. You can do this by subtracting the remaining mortgage balance from the fair market value (FMV) of the property. Companies such as Zillow have accurate and free information, and you can also pay for your own independent appraisal.
- Identify Mortgage Lender – Once you’ve established that you have at least 30% – 40% of equity, the next step is to identify a Fannie Mae-approved mortgage lender to help you with your cash out refi. Fannie Mae has a list of affordable lenders, and you can also engage a national lender such as Quicken Loans or something similar.
- Apply for Prequalification – Regardless of the lender you choose, the application process for a cash out refinance is typically the same. You’ll first apply for prequalification, where a lender will ask for basic information and give you a general loan estimate. This should give you a general understanding of how much equity you can extract from your property.
- Finalize Preapproval – From there, lenders will conduct an appraisal and ask for more investor information, such as 2 recent pay stubs, a list of total assets and debts. Further, if it’s an investment property being refinanced, investors have to show 6 months cash of reserves, 2 years personal tax returns, and a current lease agreement. The information in this stage helps lenders determine the specific loan term, rates, and costs offered for the cash out refi.
- Receive Funding – The final step is to actually receive the loan that was finalized during preapproval. This typically takes three days after the application is fully approved. During this time, the funds from the loan are wired directly to the borrower’s bank account and the borrower is responsible for paying off the old mortgage and using the remaining funds for other investments.
A cash out refinance is used by investors to extract equity from existing properties in an attempt to make other investments. The money gained from a cash out refi can be used to purchase a new property or renovate an existing property. Further, both owner-occupied primary residences as well as non-owner-occupied investment properties can be used in a cash out refi.
Cash out refinances are used by both short-term fix-and-flippers as well as long-term buy-and-hold investors. Fix-and-flippers will typically use a cash out refi to cover the down payment of a hard money loan while long-term investors use it to cover the down payment of a conforming loan.
One of the keys to real estate investing is having access to the right capital. For more information on hard money loans, read our guide on the best hard money lenders. For more information on conforming loans, you can read our article on blanket mortgages.