Cash-out refinance: how it works, costs, and when it makes sense

In a cash-out refinance, you replace your existing mortgage with a new, larger loan. The new loan pays off your old mortgage, and you receive the difference in cash at closing. For example: home worth $500,000, existing mortgage $250,000, cash-out refi to $375,000 (75% LTV) — you receive $125,000 cash and have a new $375,000 mortgage. The CFPB cash-out refinance guide covers the mechanics and what to watch for.

Conventional (Fannie Mae/Freddie Mac) cash-out refinances are capped at 80% LTV for primary residences. FHA cash-out refinances allow up to 80% LTV. VA cash-out refinances allow up to 90% LTV for eligible veterans. Investment properties have tighter limits — typically 70–75% LTV. These limits mean you must retain at least 20% equity in your home after the cash-out. The Fannie Mae cash-out refinance guidelines detail the LTV requirements and eligibility.

Only the portion of the new loan used to "buy, build, or substantially improve" the home is deductible under the Tax Cuts and Jobs Act. Cash-out proceeds used for other purposes (debt consolidation, vacation, investments) are not deductible. The deduction applies to combined mortgage debt up to $750,000 (for loans after December 15, 2017). The IRS Publication 936 on home mortgage interest and IRS Topic 505 govern deductibility.

A cash-out refinance replaces your entire first mortgage — so you pay closing costs on the full balance and take a new rate on the entire amount. It makes sense when the new rate is near or below your current rate. A HELOC or home equity loan keeps your existing mortgage intact and adds a second loan — better when your first mortgage has a rate you don't want to lose. In 2027, many homeowners with 2020–2022 loans at 3% avoid cash-out refis to preserve their rate. The CFPB equity access comparison guide covers all three options.

Cash-out refinance closing costs typically run 2–5% of the new loan amount — similar to a purchase closing. On a $375,000 new loan, costs of 3% = $11,250. These costs can be paid at closing or rolled into the loan balance (increasing the amount borrowed). Use the Loan Estimate to compare cash-out refinance offers from at least three lenders — Section A fees (origination charges) are negotiable.

Cash-out refinancing is most advantageous when: (1) your current rate is at or above the new refinance rate (no rate penalty for replacing it); (2) you need a large, one-time sum; (3) the alternative is high-rate debt (credit cards at 20%+ are definitively cheaper to replace with a 7% mortgage); or (4) the home improvement funded will increase the property's value. Check the Freddie Mac PMMS to see current refinance rates relative to your existing loan rate before deciding.