Cash-Out Refinance: Everything You Should Know

You’ve probably heard of cash-out refinance mortgages, but you may not know how they work.

In short, cash-out refinancing can help you tap into the equity you’ve built up in your home to get cash for renovations, investment opportunities, debt consolidation, business investment, or other financial goals.

If you’re interested in a cash-out refinance, here’s what you need to know about how they work in Australia.

What is Cash-Out Refinance?

Cash-out refinancing is a way of accessing your home equity by refinancing your existing home loan for a larger loan and taking out the extra money as cash.

While replacing your existing mortgage loan with a bigger one, you can leverage the home equity you’ve built and access the difference between the two mortgages (i.e., the new and existing loans) in cash.

You can use the available cash for home improvements, remodelling, consolidating high-interest debt, or meeting other financial goals.

Your bank won’t be able to control how you spend the cash you get from cash-out refinancing. Therefore, some banks ask for proof of how you plan to use that cash before letting go of it.

Where you’re accessing more than $10,000 to $50,000 as cash out, most lenders will ask you to provide evidence of the purpose of your loan. This requirement is stringent if you’re applying for a low-doc loan.

What is the Difference Between Refinance and Cash-Out Refinance?

Since taking your home loan a few years ago, your personal and financial circumstances may have changed. Moreover, you could lose money on your loan with new and more competitive home loans that may better fit your objectives.

Therefore, like some home buyers, you may look at refinancing. In simple terms, it involves shifting from one type of loan to another, i.e., a fixed rate loan to a variable rate, at a different rate and/or loan terms. You could refinance with your existing lender or a new one. In sum, refinancing gives you more flexibility with your money and allows you to adapt your home loan to your changing circumstances.

On the other hand, cash-out refinancing involves taking a new mortgage to replace your existing mortgage with a larger one and taking out the difference in cash.

Try using our Home Loan Refinance Calculator to determine your potential savings if you refinanced your home loan with a better interest rate.

How Much Cash Can You Get in a Cash-Out Refinance?

How much cash you can get will depend on several factors, key of which are outlined below:

1. The equity in your home: For cash-out refinancing, most lenders will usually allow you to borrow up to 80% of the value of your home. As such, the cash amount or equity you can access is the difference between your existing mortgage balance owed and 80% of your property’s value.
2. Purpose of the loan: Once the money is in your account, your lender will not be able to monitor how you’re using the funds, and you may be tempted to use it for other things, which could affect your financial situation. For this reason, when assessing your application, most lenders will seek details about the purpose of your loan to evaluate the risk. In addition, they’ll want proof that assures them of your ability to make monthly payments and that you’re living within your means. Some lenders may offer you up to 90% of your property’s value if they’re convinced of the evidence of the proposed use of funds.
3. Repayment capacity: Mortgage lenders often seek proof of the borrower’s ability to make their monthly mortgage payment for a higher amount of debt. In addition, they want to ensure that the new mortgage won’t affect your monthly payment. For this, your application will be reassessed. It’s most likely that you may have to provide evidence of your income, expenses, and even your credit score. As for the latter, ensure that you have at least the minimum credit score needed to qualify for the cash-out option.
4. LMI and interest rates: Where you’re ready to cough up hefty Lenders’ Mortgage Insurance, some lenders may let you borrow up to 90% of your house value. However, this will significantly increase the cost of your monthly debt payments. Likewise, the interest rate will directly influence the monthly payments on your home loan. The higher the interest rates, the lesser you may be able to borrow, and vice versa.
5. Loan term: As with all loans, as you extend your loan term mortgage, the lower your monthly mortgage payment, and the more you can borrow. Nonetheless, in this situation, your interest payments will be more over the long term than you would have paid for a shorter loan, e.g., a personal loan over five years.
6. Closing costs: If your home equity borrowing is for a loan type other than a personal loan, you will have to incur cash-out refinance expenses, including having to pay closing costs. For example, while mortgage discharge fees range from $100 to $400, and loan establishment fees range from $200 to $700, you may have to budget up to around $1,100 to close your existing home loan and refinance to another. This would affect restrict your borrowing limit.

How Does a Cash-Out Refinance Work?

If you’ve built up reasonable equity in your home, you can opt for a cash-out refinance.

The process is somewhat similar to a rate and term mortgage refinance, i.e., where you would typically move your existing loan to a new one for the same amount, usually at a lower interest rate and/or a shorter loan term.

You’ll follow the same system for a cash-out refinance, except that you also withdraw a portion of your property equity in a lump sum.

In most cases, the steps to implement if you want to access cash-out refinance are similar to when you applied for your first mortgage.

1. Determine your requirements: To begin with, you would need to determine the cash out you need and work out what your new mortgage will look like. Shortlist a lender that ticks all boxes for you depending on your requirements.
2. Application: You must submit your application and the necessary documentation. If you’re switching lenders, you need to inform your present lender so they can forward the documentation, i.e., the mortgage discharge form, to your new lender. The mortgage broker usually takes care of this if you’re with one.
3. Study the new loan documents: If approved, your lender will send you the required documents for signing the dotted line. It’s advisable to have an expert read through the offer document.
4. Settlement: The last step in this process is the settlement. The sum will be transferred to your account after deducting any appraisal fee or other charges.

Cash-Out Refinance Example

Here are two examples of how a cash-out refinance works. It’ll help you determine if this option can support your home ownership goals:

Example 1

To begin with, you will still need to maintain a deposit of 20% of the value of your home. This means you can access 80%% of your home equity. So, if your home is worth $8o0,000, and your loan is for $600,000, your useable home equity (at 80% of your property value) would be $640,000.

If you borrowed this total amount, your new cash-out refinance loan would increase from $600,000 to a larger loan of $640,000.

Now, subtracting your loan amount from your useable equity ($640,000 – $600,000) gives you $40,000. Your cash-out refinance lender will allow you to take this amount ($40,000) as cash-out when you opt for cash-out refinancing.

Example 2

Your property value is $650,000, and you owe $310,000 on your current mortgage. You have $340,000 in equity in your home, which can be used to refinance a new loan.

You could choose to refinance for $400,000, which would let you access cash of $90,000 in hand. This extra cash can be used for any purpose, such as home renovations, investment property, or even a holiday.

How Long Does a Cash-Out Refinance Take?

A cash-out refinance usually takes around 2-4 weeks. This is broadly similar to any other refinance.

Notably, much depends on your lender’s processing time, your circumstances, and how quickly and accurately you submit the required documents.

The required documents include your ID, salary slip, bank statements, home valuation, assurance, and evidence of how you plan to use the funds.

Cash-Out Refinancing for Investment Property

One everyday use for cashing out equity among home buyers is accessing funds for an investment property deposit or to purchase an investment property.

Some lenders have specific loan products with no cash-out limitations. In addition, you’ll be allowed to access loan features that help you make the most of your investments.

Do You Pay Tax on a Cash-Out Refinance?

Most lenders allow you to borrow up to 80% of the property’s value, minus the debt you have left to pay.

So if, for example, you could access $400,000 of your equity. In that case, you could make significant investments with this amount and also avail yourself of tax benefits. For example, depreciation and negative gearing on an investment property.

For a similar question raised on ATO Community, it was explained that ATO primarily looks at the use of borrowed funds. Therefore, you must apportion your loan only to claim your investment expenses. Your personal use amounts are not deductible.

Cash-Out Refinance Pros and Cons

In some circumstances, a cash-out refinance can be a great option that allows you to tap into the equity you’ve built up in your home. Nonetheless, it’s essential to know the pros and cons of this type of mortgage before you commit to one.

Some of the benefits of a cash-out refinance include:

Pro: Leverage Equity for an Investment

If you’d like to buy a property as an investment, then cash-out refinancing can help you pay the deposit if but don’t have the money saved

Pro: Line of Credit

You can take a line of credit to borrow when needed and pay interest only on the amount you withdraw. For example, you could use this money to invest in shares or a new business subject to lender policies.

Pro: Lower Interest

The money you borrow when cashing out will usually come with a lower interest rate than a margin loan.

Pro: Lifestyle Enhancement:

If you have extra cash after refinancing, you can use it to improve your lifestyle. For example, you could use the money to renovate your home and increase its value.

Pro: Consolidate Debt:

Where you have multiple debts, you may be able to consolidate them into one loan with a lower interest rate by refinancing. This can enable you to save money on interest and make it easier to manage your repayments.

Pro: Improves Credit Score

The cash-out refinance money can help you pay off smaller debts, such as your personal loans or credit card debt. Thus if you use the cash-out refinance option to consolidate your existing debt, your credit score could increase.

There are also some potential disadvantages of cash-out refinancing to consider, including:

Con: Likely to Misuse Funds:

Once your bank transfers the large lump sum amount directly into your bank account or a line of credit, they cannot impose restrictions on how you use the money.

Often borrowers do not use the funds for the intended purposes. In such a scenario, you may find yourself living beyond your means and in more considerable debt, especially if you misuse the funds.

Con: Increased Mortgage Repayments and Financial Stress

Your mortgage repayments may increase depending on how much cash you want to take out. This is because you’ll need to pay back the borrowed amount plus interest over an extended period.

Furthermore, while a cash-out may help you consolidate your loans, you may increase your financial stress in the long run.

Con: Impact on Credit Score

If you increase your loan amount, this will likely result in a decrease in your credit score. This is because you’ll have a higher debt-to-income ratio, one of the factors used to calculate your credit score.

If your application is dismissed, it could affect your credit score because of the change in your financial circumstances.

Con: Fixed Interest Home Loans

If your existing home loan is a fixed interest rate loan, you’ll have to pay break fees if you opt out before your fixed period ends.

Should I Do a Cash-Out Refinance?

Before you decide to apply for a cash-out refinance, here are some things you should consider to see if cash-out refinancing is suited to you:

1. How Much Equity Do I Have in my Home?

The amount of cash you receive will ultimately depend on the amount of equity you have in your home. The more equity you have in your home (either due to paying off your mortgage and/or the value of property value increasing), the more access to cash.

Where your equity is under 20%, you may be charged Lenders Mortgage Insurance (LMI). Where the amount is very high, it may defeat the purpose of the refinance.

2. How Much Cash Do I Need, and What Will I Use it For?

Cash-out refinancing is suitable when you want to use the cash to pay off your personal and credit card debts. In short, cash-out is appropriate only when the money is used responsibly.

3. How Will it Impact my Monthly Payment?

When refinancing your home loan, you’ll generally need to pay an appraisal fee, application, and other upfront costs. But, first, determine whether these costs(plus any ongoing fees) will be offset by the savings you’ll make on your monthly repayments.

Also, remember that you’ll need to keep up with your mortgage repayments even if interest rates rise.

4. How Long Will I be Keeping my Home?

It’s advisable to consider cash-out refinance only if you intend to stay in your home for at least 18 months. This will help you offset your losses on closing costs through lower repayments, primarily if you’ve managed to refinance at a better interest rate.

5. Consider Alternate Options

If you think that cash-out refinance isn’t the best option for you, there are a few other ways you can access the equity in your home:

Cash backs

Another option to receive cash when you are refinancing is to consider the multiple lenders offering cashback deals when you refinance your home loan. Our comprehensive guide on cashback offers may help you find a suitable refinance deal.

Personal loans

Cashing out may not always be feasible. Instead, you could take a personal loan or use your credit card for the purpose. This is because even though you may get a better interest rate, you could pay much more in the long run.

Cash Out Refinance vs Home Equity Loan

Cash-out refinance, and home equity loans are two options that allow you to tap into the equity you’ve built in your home. 

They are similar in that for both loan types, you can borrow against the equity in your mortgaged property and receive a lump-sum cash payment. Also, you cannot borrow 100% of your equity for both.

Nonetheless, cash-out refinancing and home equity loans are not the same. Many home loan borrowers struggle to choose between cash-out refinance or a home equity loan. Therefore, it’s essential to understand the critical differences between them before making a decision.

1. Cash-out refinance loan: An entirely new mortgage pays off your old mortgage and gives you extra cash to use as you see fit. In most cases, you can opt for a cash-out refinance if you’ve had your property for sufficient time to build equity or if its value has risen.
2. Home equity loan: In contrast, a home equity loan is a second mortgage that you will have to pay separately, typically at a fixed rate of interest. A home equity loan does not replace your existing mortgage. A home equity loan can be either:
3. Top-up loan: Combines your existing home loan and new loan against the same property into one account.
4. Split loan: Divides your existing home loan and new loan against the same property into two separate accounts.

Overall, both types of loans allow you to access your home equity. Nonetheless, cash-out refinancing works comparatively cheaper most of the time. This is because you’re taking out a new loan, i.e., it’ll be paid off first if you default and fail to repay your home loan or declare bankruptcy.

Let Joust Match Your Refinancing Dreams

Putting your mortgage on the Joust online marketplace might be a good idea if you’d like to free up cash to meet your day-to-day expenses.

Our Instant Match platform will help you access reputed Aussies lenders for a suitable home loan refinance deal. This process is safe and free for home loan borrowers. So sign up today and take the first step towards your cash-out refinance.

FAQs

How Much Equity Do I Need for a Cash-Out Refinance?

Multiple lenders will typically let you borrow up to 80% of your property value. Where your Loan to Value Ratio (LVR) is more than 80%, you may not be able to access cash out.

However, some lenders allow loan borrowers to cash out refinances where they don’t have sufficient equity by charging Lenders Mortgage Insurance (LMI).

The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.