- Home
- Home Loans
- Articles
- What is cash-out refinancing, and how does it help you?
What is cash-out refinancing, and how does it help you?
Key highlights
Whether you want to renovate a home, pay for a wedding or make some new investments, if you need some extra cash, you could consider leveraging the equity in your home. This is also known as cash-out refinancing, and it’s a competitive option for some homeowners to consider.
Refinancing your home loan is where you switch from one mortgage or lender to another, generally to nab a better home loan interest rate or deal. But you can also access your home equity by refinancing your mortgage and increasing the loan size, allowing you to take the extra money out as cash.
What are the benefits and risks of a cash-out refinance?
Borrowing cash while refinancing could be used to:
- 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 may be more suitable if you don’t need to borrow one large lump sum.
With a line of credit, you can borrow and repay extra money based on your needs, and only pay interest on the money you withdraw. Some lenders will allow you to invest the money you borrow in shares or purchase a new business, but this is decided on a case-by-case basis, depending on the level of exposure a lender is comfortable with.
Keep in mind that by increasing your loan amount, you will also increase 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 higher mortgage repayments that come with a bigger loan, it may be worth prioritising reducing your costs in the refinancing process, such as 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 charges, such as an offset account.
Remember that when you refinance, you may 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 could mean paying hundreds of thousands of dollars more in interest than if you just stuck to repaying the mortgage over the original loan term, even if your new interest rate is lower. 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 calculating your current property value, and subtracting how much you currently owe on your loan. Keep in mind that a lender will not allow you to access all the equity in your home, as they will want you to maintain a minimum Loan to Value Ratio (LVR) to help ensure you’re not in a risky borrowing situation (and avoid having to take out costly Lenders Mortgage Insurance). This means you may only be able to access up to 80% of the available equity in the home.
For example, imagine a homeowner took out a $400,000 mortgage to buy a property worth $500,000 several years ago. Today, they have an outstanding debt of $200,000. Assuming the property’s value has not fallen, they would have built up $300,000 in home equity. If the property’s value had grown over time, they may have had even more equity available.
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, essentially taking out 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 current lender, or consider taking the opportunity to compare the home loan market. It’s likely that the market has changed since you took out your original loan, and that there may be more competitive options available that may better suit your financial situation and goals. 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 can affect 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 can 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 can borrow up to 80% of a property’s value with a home loan before also needing to cover the cost of LMI. With a cash-out refinance loan, the amount you can borrow will be based on your available equity or usable equity, which is the difference between what you still owe and 80% of your property’s value.
Lenders may also have their own limits on how much they’re willing to lend you, even if you have plenty of usable equity. Most lenders may ask you for your loan’s purpose when you apply, and could reject the application if it’s deemed too financially risky. 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 financial stress that could lead to repayment issues. If you think you’re falling behind with your repayments, or are looking to refinance 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 suitable option.
Home equity loan and cash-out refinance: What’s the difference?
Cash-out refinance loans and home equity loans offer two different ways to use 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 you previously owed. Generally, you’ll be able to do a cash-out refinance if you’ve had your property long enough to build equity, or if its value has risen over time. 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 intere
Compare home loans in Australia
Product database updated 12 Oct, 2024
Share this page
Latest home loans articles
Home Loans
03/10/24 . 8 min read
Asking for a rate cut: how to negotiate a better home loan rate
If you don't ask you don't get. If you are unhappy with your current home loan it's perfectly acceptable to approach your lender and ask for a better rate.
Alex Ritchie
Personal Finance Editor