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What is cash-out refinancing, and how does it help you?

Alex Ritchie avatar
Alex Ritchie
- 7 min read
What is cash-out refinancing, and how does it help you?

Whether you want to renovate a home, pay for a wedding or make some new investments, if you need some extra cash you may have considered leveraging the equity in your home. This is also known as cash-out refinancing, and is a competitive option to consider for some homeowners.

Refinancing your home loan is where you switch from one mortgage or one lender to another. This is generally done to nab a better home loan interest rate or deal. But in the instance of getting cash out, you will be accessing your home equity by refinancing your mortgage and increasing the loan size in the process, allowing you to take out the extra money as cash. 

What are the benefits and risks of a cash-out refinance?

Borrowing cash while refinancing may help pay the deposit for a second property, fund a large purchase, or consolidate debts, like credit cards and personal loans. You could also use the money for a home renovation project by opting for a line of credit, which is more suitable if you need the money in installments. 

With a line of credit, you can borrow and repay the extra money on a need-basis, only paying interest on the money withdrawn by you. Some lenders will also allow you to invest the money in shares or purchase a new business, but this is decided on a case-to-case basis. It may be dependent on the level of exposure a lender is comfortable with. 

Whatever your home loan purpose, it’s worth keeping in mind that by increasing your loan amount you will understandably be increasing your mortgage repayments. It is crucial that you check your budget to ensure you can afford the new higher loan repayments before you consider refinancing. 

Due to the inevitable higher mortgage repayments that come with a bigger loan, it may be worth prioritising reducing your costs in the refinancing process. This may be done by opting for a low interest rate home loan, or one that charges fewer fees. You could even look at switching to a loan with helpful features that allow you to reduce your interest repayments, such as an offset account. 

There is also a risk that you may refinance and extend your home loan term again. Most loan terms are 25-30 years, and if you’ve been paying off your mortgage for, say, a decade and then refinance to a new 30-year loan term, this would likely result in paying hundreds of thousands of dollars more in interest than if you just stuck to repaying the mortgage over the original loan term. Be sure to double-check the new loan term suits your goals before you sign on the dotted line for a cash-out refinance. 

Benefits

  • Access to additional funds
  • Could be used to renovate and increase or replenish home equity
  • Could be used for new investments that grow your wealth

Drawbacks

  • Risk of extending your loan term
  • Increases your loan amount, meaning higher mortgage repayments

How do you actually get cash out from refinancing?

The steps to refinancing your home loan to access equity typically include:

1. Determine the equity you have in the property

This can be done by discovering your current property value, and subtracting the loan amount. Keep in mind that a lender will not allow you to access all the equity in your home, as you generally need a buffer (like your home loan deposit) to ensure you’re not in a risky borrowing situation. This means you may only be able to access up to 80% of the available equity in the home. 

For example, a homeowner took out a $400,000 mortgage to buy a property worth $500,000 several years ago. Currently, they have an outstanding debt of $200,000. Assuming that the property’s value has not fallen, they would have built up $300,000 in home equity. 

Now, the homeowner wants to convert $50,000 of their equity into cash to pay for a home renovation project they’ve been daydreaming about. The homeowner chooses to refinance, and take out essentially a new mortgage worth $250,000. This includes the outstanding original mortgage debt, and the $50,000 they wanted for renovations. 

2.Choose your new home loan or lender

You could choose to refinance with your same lender, or consider taking the opportunity to compare the home loan market. It’s likely that since you took out your original loan that the market has changed, and that there may be more competitive options available. Tools like comparison tables and calculators can come in handy here to filter down and create a shortlist of refinancing options that best suit your current financial situation. 

3. Assess your financial situation

Just because you’ve qualified for a home loan once doesn’t mean you are guaranteed refinancing approval. You may have recently changed jobs, suffered a loss of income, or racked up a considerable credit card debt. All of these factors go into determining your eligibility for your next home loan application. Before you consider refinancing, take stock of your financial health, including your credit score, and ensure you’re in a positive position before applying. 

4. Make your application

You’ve crossed your financial t’s and dotted your i’s. Now is the time to consider submitting your application to refinance your home loan. Some lenders will let you access the equity in your home as a flexible line of credit instead of a lump sum payment, meaning you have the flexibility to borrow and repay money up to your limit as required. Like other mortgages, the typical repayment term offered is 25-30 years with a choice between fixed and variable cash-out refinance mortgage rates.

How much can you borrow with a cash-out refinance?

Typically, you’ll be able to borrow up to 80% of a property’s value with a cash-out refinance loan, also known as your available equity. This means you’ll have access to the cash amount or equity that is the difference between what you still owe and 80% of your property’s value. 

Keep in mind that most lenders may ask you to state the purpose of the loan when applying to assess their risk, and could reject the application on this basis. Lenders will also require proof that you’d be able to meet the repayments for a higher amount of debt. 

Lenders want to minimise their risk while ensuring your new mortgage won’t put you under any financial stress leading to repayment issues. If you think you’re falling behind with your repayments, or are looking to refinance just to get some extra cash for your day-to-day expenses, it might be best to speak with a mortgage broker or financial planner to work out a more suitable option. 

Home equity loan and cash-out refinance: What’s the difference?

Cash-out refinance loans, and home equity loans are two different options to leverage the equity you’ve built in your property. 

A cash-out refinance is where you essentially take out a brand new mortgage with a higher loan amount than what you previously owed on your house. Generally, you’ll be able to do a cash-out refinance if you’ve had your property long enough to build equity or its value has risen. Some lenders will let you access the money as a flexible line of credit instead of a lump sum payment meaning you get periodical payments when needed. Like other mortgages, the typical repayment term offered is 30 years with a choice between fixed and variable cash-out refinance mortgage rates.

On the other hand, a home equity loan is a second mortgage that doesn’t replace your existing mortgage. If you’re taking out a home equity loan, you’ll be taking out a second mortgage that will be paid separately, usually at a fixed rate of interest. 

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Product database updated 22 Jun, 2024

This article was reviewed by Personal Finance Editor Mark Bristow before it was published as part of RateCity's Fact Check process.