Define Cash Out Refinancing - A Simple Definition

Reader Question: I am thinking about refinancing my home to take advantage of the very low interest rates we are seeing right now. We are also planning a remodeling project for our house. Is this a scenario where cash-out refinancing might work? Can you define this for me?

Let’s start by defining this term. You can find hundreds of definitions online, but I would define a cash-out refinance like this: It’s when you replace your current home loan with a larger one, so you can have some extra cash left over after the transaction.

In other words, if I currently owe $200,000 on my home, I could (theoretically) refinance the house for $215,000 and have $15,000 left over after closing. I could use this money for a home improvement project, to pay off some other form of debt, for my kid’s college tuition, etc. It’s my money,  so I can use it how I want. Ideally, I would also secure a lower interest rate on my mortgage, which could save me money by lowering my monthly payments over the long haul. So I’ve basically done two things at once — I’ve replaced my existing mortgage with a new one, and I’ve received a loan for $15,000. This is how a cash-out refinance works.

That’s how I would define cash-out refinancing in simple terms. The next logical questions are: (A) can I qualify for this type of refi and (B) when does it make sense to use it?

A cash-out refi is not the same as a home equity loan, though both of them do leverage your current equity. With an equity loan, you actually keep the original mortgage and take out a second loan. Cash-out refinancing, on the other hand, replaces the original mortgage completely.

Generally speaking, it’s best to use a cash-out refi for a long-term expenditure (such as college tuition) or one that creates value in some way (like a home improvement project). Also, keep in mind that you might have to pay PMI on the new loan, if it’s for more than 80% of your home’s value. You’ll need to figure out the full cost of the refinance and then compare it to what you might save through lower interest rates. Only then can you determine if it’s the best move to make.

So that’s how I would define cash-out refinancing in a nutshell. Elsewhere on this website, you can find dozens of other articles and questions related to this topic. Hope this helps you out. Good luck.

Filed under: Refinance Questions