What Is a "Cash-Out" Loan?

If you've owned your home for a while, you may be sitting on a substantial amount of equity — the difference between what your home is worth and what you still owe. A cash-out refinance is one of the most common ways homeowners put that equity to work. Here's how it works and what to consider.

How a cash-out refinance works

In a cash-out refinance, you replace your existing mortgage with a new, larger loan and receive the difference as cash. For example, if your home is worth $400,000 and you owe $250,000, you have $150,000 in equity. Lenders typically let you borrow up to a percentage of your home's value, so you might refinance into a new loan and walk away with cash you can use — all wrapped into a single monthly mortgage payment.

What homeowners use it for

• Home improvements and repairs that add value
• Consolidating higher-interest debt into one lower-rate payment
• Major expenses like education or a large purchase
• Building an emergency cushion

Because the loan is secured by your home, the rate is usually far lower than credit cards or unsecured loans.

The trade-offs to weigh

A cash-out refinance resets your mortgage and uses your home as collateral. You're borrowing against your equity, so you'll owe more, possibly pay over a longer period, and your home is on the line if you can't repay. It's a powerful tool, but not free money.

Also factor in closing costs, which typically run a few percent of the loan amount, and whether the new rate is better or worse than your current one.

Cash-out refinance vs. a HELOC

A cash-out refinance replaces your whole mortgage with one new loan. A home equity line of credit (HELOC) or home equity loan is a second loan that sits on top of your existing mortgage. If you have a great rate on your current mortgage, a HELOC may let you tap equity without disturbing it; if rates have fallen, a cash-out refinance can let you access cash and improve your rate at once.

Do you qualify?

Lenders generally look for a solid credit score, enough equity (often requiring you to leave some in the home), a manageable debt-to-income ratio, and a stable income. The stronger each of these, the better your terms.

The bottom line

A cash-out loan can be a smart way to put your equity to work at a relatively low rate — especially for value-adding improvements or to consolidate expensive debt. Just go in clear-eyed about the costs and the fact that you're borrowing against your home, and compare a few lenders before you decide.