How To Refinance Your Loan and get Cash Out
If you're looking for extra cash for an upcoming expense, you might consider using your mortgage instead of turning to high-interest loans. Keep reading to learn what a cash-out refinance is and if it could be the right option for you.
What is a cash-out refinance?
A cash-out refinance involves refinancing your current mortgage to tap into the equity you've built up in your home. The lender will approve a new mortgage for a larger amount than your current loan balance, and you can receive the difference in cash.
These funds can be released into your bank account, offset account, or as a line of credit. While it provides an alternative to high-interest loans, it’s important to note that a cash-out refinance could extend the length of time it takes to pay off your mortgage.
What is Home Equity?
Home equity is the portion of your home’s value that you own outright. To calculate your equity, simply subtract the remaining loan balance from your home’s current market value.
To get an accurate estimate of your home’s equity, you'll need to know its current value. This may require a formal property valuation, which you can organise yourself or have your lender perform during the refinancing process.
Here’s an example of home equity:
If your home is valued at $800,000 and your remaining loan balance is $200,000, your equity will be $600,000 (75%).
Your equity increases when your property’s value rises. There are various ways to boost the value of your property, such as:
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Renovations (e.g., kitchen or bathroom makeover)
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Adding extra bedrooms to your property
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Minor refurbishments (e.g., painting or replacing carpets)
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Cosmetic enhancements (e.g., re-tiling the bathroom or improving landscaping)
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Performing repairs or improvements that enhance the property’s functionality
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Building a granny flat for additional rental income or living space
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Living in a desirable or high-growth area
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Benefiting from economic conditions that are driving increased property values
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neighbourhood with low crime rates and good transport links
How does a cash-out refinance work?
The process of a cash-out refinance is similar to any other home loan refinance. Here's a general overview of the steps involved:
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Work out your equity – Start by calculating how much equity you hold in your home. While a property report can provide an estimate, a formal calculation will be done by the lender later.
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Determine why you need the cash – Lenders typically ask for your intended purpose for the funds, so it's essential to be clear on your plans (e.g., home improvements, debt consolidation, etc.).
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Research and compare home loans – Look at various loan options to find one that suits your needs. It’s important to compare interest rates, fees, and other terms.
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Speak to a mortgage broker – For tailored advice on your specific situation, a mortgage broker can help you navigate the process.
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Apply for the new mortgage – Once you've chosen your loan, you'll apply for it, and a property valuation will usually take place during this step.
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Switching lenders – If you are changing lenders, the new lender will send the mortgage discharge form to your old lender to clear the existing loan.
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Prepare for settlement – Once everything is processed, prepare for the settlement date when the funds will be released.
Read more about the refinancing process to get a better understanding of each step.
How much cash can you get out by refinancing?
The amount of cash you can access through a cash-out refinance depends on several factors, primarily the equity you have in your home. If you've paid down a significant portion of your mortgage or if your property has increased in value, you’ll have more equity to draw from.
Lenders typically allow you to borrow up to 80% of your home’s value. For example, if your property is worth $500,000, you could borrow up to $400,000. However, if your Loan to Value Ratio (LVR) exceeds 80%, you may not be eligible to access cash. Some lenders may allow you to proceed with a cash-out refinance if your equity is below 20%, but this could involve paying Lenders Mortgage Insurance (LMI).
Restrictions on cash-out refinances
Lenders often impose restrictions on cash-out refinances to safeguard both their interests and your financial well-being. This is especially true for borrowers with lower equity, as lenders will want to ensure that any cash taken out is used for a legitimate purpose. For example, the lender may require proof that the cash will be used for things like home improvements, debt consolidation, or other approved investments.
What are the reasons for cash out refinancing?
1. Using your equity for home improvements
If you're eligible for a cash-out refinance, using your home equity to fund home improvements can be a smart financial move. Unlike credit cards or personal loans, a cash-out refinance typically comes with lower interest rates, making it a more cost-effective way to access funds for renovations or upgrades.
However, it’s important to note that not all types of renovations are eligible for cash-out refinancing. Structural changes like knocking down walls or building a granny flat are often better suited for a construction loan rather than a cash-out refinance.
Additionally, while home improvements are a popular use of cash-out refinance funds, you may also be able to use the money for other purposes, such as funding a holiday or purchasing a car. Keep in mind that lenders may require you to outline the intended use of the funds, and some restrictions may apply depending on the purpose of the cash.
2. Investing in property
One potential use for cashing out your equity is getting the funds you need for an investment property deposit.
3. Investing in the stock market
A cash-out refinance can provide the funds needed to diversify your investments by purchasing shares or other financial assets. By unlocking the equity in your home, you can tap into opportunities outside of property investments. However, keep in mind that stock market investments carry risks, so it’s important to consider your financial goals carefully.
4. Paying off debt
One of the most common reasons for a cash-out refinance is to pay off high-interest debts, such as credit cards or personal loans. Consolidating these debts into your home loan allows you to benefit from a lower interest rate, potentially saving you money in the long run. This can simplify your finances and reduce stress, but it’s essential to assess if it’s the best approach for your overall financial situation.
What risks are involved with cash out refinancing?
1. You Will Owe More
When you access equity from your home, the amount you owe on your mortgage will increase. This means your repayments will likely go up as well, and you’ll need to adjust your budget accordingly to accommodate these changes.
2. Enabling Bad Habits
One common risk of using cash from a home equity loan is falling into a cycle of bad financial habits. For instance, using secured debt to pay off unsecured debt, like credit card balances, can lead to reliance on your home loan for non-essential spending. This can snowball and leave you in a worse financial position down the line.
3. Overestimating the Power of Your Mortgage
Your mortgage isn’t a quick fix for every financial issue or an easy source of funds for lifestyle expenses like holidays or luxury items. Relying on your home loan for unnecessary purchases can leave you in a precarious financial situation and delay your long-term goals, such as paying off your home.
4. Increasing Your Mortgage Repayments
A significant downside of a cash-out refinance is that your home loan debt will increase, which in turn, will raise your mortgage repayments. To manage the larger loan balance, you may need to extend your loan term, which could result in paying more interest over the life of the loan.
5. Fixed Interest Home Loans
If you’re on a fixed-rate home loan, be prepared for break fees when you opt for a cash-out refinance. These fees are charged because you’re refinancing before the end of your fixed-rate period. Before refinancing your fixed-rate loan, it’s essential to check how much the break fee will be and evaluate if the refinance is still worthwhile.
How Long Does It Take to Get Cash Out of Your Home Loan?
Typically, the process of a cash-out refinance can take anywhere from 2 to 4 weeks, depending on the lender's processing times, your individual circumstances, and how quickly you submit all the necessary documents.
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in Residential & Commercial Banking