Cash-Out Refinance Options for Your Paid-Off Home

It’s exciting to finally have no more mortgage payments. But now that you have all that equity in your home, is it possible to get another mortgage to use for other purchases?

You bet you can. Lenders are happy to use the real estate equity you have built up in your home to give you a loan for other needs.

Access home equity with a cash-out refinance

Taking out a new loan on your paid-off house is a big decision, and you really need to think about the ramifications. If you fall behind on repayment, you could risk foreclosure. Whether it’s the right choice will depend on your personal financial situation.

Any loan that isn’t considered a purchase is called a refinance — despite that fact that there isn’t a loan to pay off.

Lana Jern, Owner of Uptown Mortgage

“Anytime you are taking money against your property, you are taking a debt that you didn’t have before,” Jern says. “How you will repay that loan is something to consider.”

She recommends that if you need a lump sum of cash, you consider another way to find the loan amount than borrowing against your primary residence. It’s possible that another type of loan might offer lower interest rates. For example, if you need to pay for your daughter’s college tuition and she needs a car, too, there might be several ways to find the funds instead of getting a new mortgage. Maybe your daughter can apply for a student loan through her college or the government, and you can acquire a low-interest car loan for the car she needs.

Conventional loans, HELOC & more: Refinance options

When you’re getting a cash-out refinance, you have a number of different home loan options to choose from. Different loan types carry different terms, different loan limits and some require monthly mortgage insurance.

The best option for converting your homeownership into cash will depend greatly on your personal finances.

Cash-out refinance: FHA vs conventional mortgages

If you’re sure a cash-out refinance is the right option, you can get a conforming loan backed by Freddie Mac or Fannie Mae, or you can get one through the FHA loan program (which is backed by the Federal Housing Administration).

With a cash-out refinance, borrowers can take out 80 percent of the home’s value in cash. This unaccessed equity is functionally similar to the down payment made when home buying.

With an FHA cash-out refinance, the FHA loan limit is 85 percent of the value of your home. It will still be subject to FHA mortgage insurance which means you’ll have to pay a mortgage insurance premium (MIP) for the life of the loan and an upfront mortgage insurance premium. In addition to the cost of the insurance payments, an FHA cash-out refinance is also likely to carry a higher interest rate especially for borrowers with lower credit scores.

For some people, taking out a cash-out refinance for an investment can be quite profitable.

“Let’s say you take out $100,000 cash from a refinance and invest it into creating more assets. If you put back more than what it cost you, then great,” she says.

For more information on the pros and cons of each, check out these articles:

• Conventional cash-out refinance
• FHA cash-out refinance

Alternatives to cash-out refinance: HELOC & reverse mortgages

A cash-out refinance isn’t the only way to turn your home equity into cash. It’s also worth talking to your mortgage lender about a home equity line of credit (HELOC) or a reverse mortgage.

If you need house repairs, Jern says, a home equity loan may work out better in the long run.

“If your home is paid off, you can apply for a home equity loan without much hassle,” she says. “However, a HELOC should be put in place before any emergency happens. It lasts 10 years, and you never ever have to take money out of it. But if you need it, it is there.”

Keep in mind though, if you haven’t set up a HELOC and your husband breaks his leg and can’t work, the lender won’t then give you the equity line of credit.

It doesn’t cost anything to set up a HELOC. This is a very inexpensive way to set up some security for the future. If you do a cash-out refinance, then you’ll have to pay closing costs. A HELOC is the cheapest money you’ll ever get.

Lana Jern, Owner of Uptown Mortgage

Reverse mortgages can help older homeowners with things like medical expenses. The government doesn’t let you take more than 50 percent out in a refinance than the value of the property. The owners of the house can live in their home the rest of their lives with this sort of loan.

“Reverse mortgages can be an affordable option for older people that allows them to have the lifestyle they want like the ability to travel or take care of their house,” she says.

For more information about these other mortgage options, check out the full articles below:

• Home equity line of credit (HELOC)
• Reverse mortgages

A final note on cash-out refinances

When you get a new mortgage loan you’re taking on more risk. You’re adding another monthly payment to your budget. And, you’re going through the underwriting process with all the verifications and paperwork required that you did when you bought your home.

The government has put in some laws to protect consumers in situations like cash-out refinancing and HELOCs. Under the Truth in Lending Act, you have the right to rescind your HELOC or refinance loan within three days of closing.

“The government wants people to have time to go home and determine if they can really afford it,” Jern says.

For example, a cash-out refinance might make sense if you’re planning to make home improvements. You might use the money to pay off higher-interest credit card debt — as long as you don’t accrue a new outstanding balance on credit cards again afterward.

Bottom Line: Make sure that a cash-out refinance is the best financial choice for your situation — there may be other financing options available to accomplish your goals.