What is Equity Take-Out Refinance: How To Access Cash From Your Home?
A cash-out or equity take-out refinance lets eligible homeowners tap into their home’s built-up value, turning it into cash they can use. This option covers expenses like paying off high-interest debt or home upgrades.
An equity take-out refinance can be a smart choice for some homeowners. Still, it’s essential to understand how it works, the costs involved, and any possible downsides before proceeding.
How Does Equity Take-Out Refinancing Work
Like any mortgage refinance, an equity take-out refinance means swapping out your current mortgage for a brand-new one.
In an equity take-out refinance, you apply for a mortgage that’s larger than your current balance. If approved, the new mortgage replaces your old one, and you get the extra amount in cash to use however you’d like.
Many lenders permit eligible homeowners to borrow up to 80% of their home’s appraised value. However, you’ll need more than 20% equity to qualify. Lenders will also consider factors like your credit score and debt service ratio (DSR) when evaluating your application.
For instance, imagine your home is valued at $400,000, and you still owe $300,000 on your current mortgage. If you decide to borrow a maximum of 80% of your home’s worth, you could refinance with a new mortgage of $320,000. Once you pay off the $300,000 balance, you’ll have $20,000 in cash to use as you wish.
Homeowners build equity over time through their regular mortgage payments and when their home’s value rises. To avoid penalties for breaking your mortgage contract, it’s usually wise to wait until the end of your mortgage term, or maturity date, before refinancing.
Major Ways to Use an Equity Take-Out Refinance
The money you get from a refinance can be used for many different expenses. Homeowners often tap into their equity for things like:
- Financing home upgrades: The funds from an equity take-out refinance can cover costly home upgrades and renovations that might even boost your property’s value. Many homeowners choose to use this money for projects like kitchen updates, landscaping, or purchasing new appliances.
- Paying off high-interest debt: If you have significant credit card or other high-interest balances, refinancing can provide cash to combine those debts. This approach can lower the amount you pay in interest and simplify the repayment process.
- Launching a small business: Entrepreneurs can use the cash from a refinance to cover startup expenses or ongoing business costs. An equity take-out refinance usually offers lower interest rates compared to most personal or business loans, making it a cost-effective funding option.
- Investing in Real Estate or Stocks: The cash from a refinance can be used to invest in stocks or even to buy and renovate real estate. However, investing this way comes with risks, as there’s no guarantee your returns will be positive—you could end up losing money instead.
Paying for education: The cash from a refinance can help cover tuition costs for gaining new skills or earning certifications. However, depending on the expenses, you might need to supplement it with personal savings or additional funding sources.
Alternatives To Equity Take-Out Refinancing
If you need cash for a project, to cover costs, or for investments, refinancing isn’t your only solution. Here are some alternative ways to get the funds you need:
Home Equity Loan
You can also access cash by taking out a home equity loan, which lets you borrow up to 80% of your home’s value, minus what you still owe on your mortgage. Like an equity take-out refinance, this loan provides a lump sum, which you repay through fixed monthly payments. Since the loan is secured by your home, the lender could take possession of your property if you fail to make payments.
A home equity loan is different from an equity take-out refinance because it’s considered a second mortgage, meaning it’s an extra debt on top of your primary mortgage. Typically, the interest rates for home equity loans are higher compared to those of equity take-out refinances.
HELOC
Another option for homeowners is a home equity line of credit (HELOC), which lets you borrow against your home’s equity. It works like a credit card, where you’re given a set credit limit to use and repay over time. HELOCs can either be tied to your mortgage or stand-alone, with payments that vary based on changing interest rates.
Similar to a home equity loan, failing to make timely payments on a HELOC could result in losing your home.
Reverse Mortgage
A reverse mortgage, designed for homeowners aged 55 or older, allows you to convert up to 55% of your home’s value into cash for personal use. This money is tax-free and doesn’t impact your eligibility for Old Age Security (OAS) or Guaranteed Income Supplement (GIS) benefits. You can receive the funds as a lump sum, regular payments, or as needed through withdrawals.
Reverse mortgages usually have higher interest rates compared to home equity loans, HELOCs, or equity take-out refinances. Additionally, there are various fees involved in securing a reverse mortgage, on top of the closing costs.
What You Need For An Equity Take-Out Refinance
To qualify for an equity take-out refinance, you’ll need to meet your lender’s mortgage criteria. This includes having a solid credit score, a healthy debt-to-income ratio (DSR), and proof of a steady income.
While requirements may differ from one lender to another, you’ll generally need to have:
- More than 20% equity in your home
- At least a 500 – 650 credit score
- Typically, a gross debt servicing (GDS) ratio and total debt servicing (TDS) ratio both below 50%
- Verified documentation of your identity, income, and employment
Most lenders will request an appraisal to assess your home’s value, and you may also need to redo the mortgage stress test.
Pros and Cons of Equity Take-Out Refinancing
An equity take-out refinance can be a good choice for some, but it’s important for borrowers to be aware of the possible downsides.
Pros
- You can access higher loan amounts compared to certain other financing options.
- You may qualify for a lower interest rate compared to taking out an unsecured loan.
- You can use the funds for home upgrades or to pay off high-interest debt, saving money on interest in the process.
Cons
- Borrowing a larger amount may result in a higher interest rate.
- If you fail to make payments on your new mortgage, your home could be at risk of foreclosure.
- Refinancing comes with closing costs, along with additional fees you’ll need to cover.
Steps To Get An Equity Take-Out Refinance In Canada
Applying for an equity take-out refinance follows a similar process to applying for a mortgage, but there are a few extra factors to keep in mind:
- Review your eligibility. Start by confirming that you have over 20% equity in your home. Next, check if your credit score and debt-service ratio (DSR) meet the requirements for a refinance.
- Determine how much money you need. Next, figure out the amount of cash required to reach your refinancing goal. If you need more than what the refinance can provide, consider other funding options. Alternatively, if you need less than expected, a personal loan could be a good alternative to explore.
- Determine how much you can take out. Start by estimating your home’s current value. Then, multiply that number by the percentage of your home’s value you plan to borrow (up to 80%), expressed as a decimal. Finally, subtract your remaining mortgage balance from that result to see how much cash you might be able to access. Let’s revisit that example:$400,000 x .80 – $300,000 = $20,000 cash from refinancing. In this case, let’s say your home is worth $400,000 and you plan to borrow 80% of that amount, which is $320,000. After paying off your $300,000 mortgage, you would have $20,000 in cash from the refinance.
- Explore your lender choices. While refinancing with your current lender is an option, it’s a good idea to compare offers from other lenders to ensure you’re getting the best deal available.
- Apply for the refinance. Once you’ve selected a lender, complete the application and make sure to provide all required documents, such as proof of income and employment.
- Finish any remaining refinance steps. You’ll probably need to pass a mortgage stress test and have your home appraised. The results of both could impact whether your refinance is approved.
- Once approved, get your new mortgage and cash. After the new mortgage is finalized and the old one is paid off, you can use the remaining cash as planned. Just be sure to stick to the new payment schedule to avoid risking default.
Final Word
An equity take-out refinance, also known as a cash-out refinance, allows you to access extra cash while securing a new mortgage. It can be a great choice if you need the funds and can lock in a favorable interest rate. However, refinancing can come with high costs, particularly if you end up breaking your existing mortgage agreement. If you’re unsure whether refinancing is the right move, it’s a good idea to consult with a licensed mortgage broker for expert advice.