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Using a Cash-Out Refinance for a Second Home

Written by Ashley Sutphin Posted On Wednesday, 29 June 2022 00:00

There are ways to put the equity you have in your home to use. One way is to use it to buy a second home.

Specifically, one option is to use a cash-out refinance to buy a second home, but there are some things to know first if you're doing so.

What is a Cash-Out Refinance?

A cash-out refinance a way to refinance your mortgage, converting your home equity to cash. You get a new mortgage for more than your previous balance, and then the difference is paid to you in cash.

In a general sense, one of the most popular reasons people refinance is to want more favorable terms than they have with their existing loan. For example, you might refinance to lower your monthly payments or take advantage of a lower interest rate. With a cash-out refinance, your primary goal is probably tapping into the equity in your home in the form of cash.

Your home is collateral for a new loan in a cash-out refinance. Then, you’re getting a new mortgage for a larger amount than what you owe currently.

Buying a House with a Cash-Out Refi

You can only do a cash-out refinance if the value of your home currently is significantly more than your remaining balance left on your mortgage.

A lender will let you withdraw up to 80% of the current value of your home, minus your remaining balance.

You can then use what you’re able to receive as a down payment on the next property.

You still have to qualify, as with a conventional refinance loan.

Lenders, at a minimum, will require a credit score of 620 or higher in most cases and a debt-to-income ratio of 50% but preferably less.

If you’re going to use the proceeds you get from your cash-out refi to buy an investment property, you’ll have to plan on putting down anywhere from 15 to 25%.

A lower down payment will be accepted if you buy a primary residence usually.

Lenders don’t have any guidelines against using the proceeds you get from a cash-out refinance to put toward the down payment of another property.

Considerations to Keep In Mind

When applying for a cash-out refi, you select between either a fixed-rate or a variable-rate loan. If you get a variable-rate loan, your payments can go up, depending on the interest rate.

If you do a cash-out refi, your new loan’s interest rate can be higher than the interest rate on your original loan so that you could be paying more overall through the duration of your loan.

You have to decide whether you’d be able to make up for the additional interest you’d pay when you buy another property. You’re also extending your current debt’s repayment period, meaning it’s not always the right choice.

You’ll pay closing costs of anywhere from 2-5% on your new refinance mortgage, which are taken from your cash payout. You can’t roll them into the mortgage.

Another alternative to explore is a home equity loan that you take out against your house. Home equity loans have no closing costs, which is a big upside. This could be less expensive than a cash-out refinance if your current mortgage has a lower interest rate than what you’d qualify for.

Finally, the biggest downside you have to remember with a cash-out refi is that your primary home becomes your collateral, even if you’re using it to buy another home. If you default, your lender can avoid foreclosure on your primary home.

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