Can I Cash Out Refinance to Buy Another Property?

Leveraging equity in an existing home to acquire additional real estate is a common financial strategy. A cash-out refinance allows individuals to tap into their home’s value, potentially unlocking capital for new investment opportunities. Understanding this process can provide a pathway for those looking to expand their property portfolio or secure a second home.

Cash-Out Refinance Fundamentals

A cash-out refinance replaces an existing mortgage with a new, larger one. The difference between the new loan amount and the original mortgage balance is disbursed to the borrower as a lump sum of cash. The new mortgage pays off the old one, creating a single, larger debt secured by the property.

Home equity represents the portion of your home you own outright, calculated as the property’s current market value minus the outstanding mortgage balance. For example, if a home is valued at $400,000 with a $100,000 mortgage, the homeowner has $300,000 in equity. Lenders typically permit borrowing up to 80% of the home’s value, leaving at least 20% equity. This means a borrower might access a new loan up to $320,000, allowing a $220,000 cash payout after paying off the original $100,000 mortgage.

This financial tool differs from a standard refinance, which primarily adjusts interest rates or loan terms without providing cash back. With a cash-out refinance, the homeowner receives funds directly from their home’s accumulated value. The new loan will come with its own interest rate and repayment terms, which may differ from the original mortgage.

Borrower and Property Requirements

To qualify for a cash-out refinance, borrowers must meet specific financial criteria. Lenders assess credit score, debt-to-income (DTI) ratio, and the home’s loan-to-value (LTV) ratio. A strong financial profile helps secure favorable loan terms and interest rates.

Credit score requirements typically range from 620 for conventional loans, though 680 or higher is preferred for better rates. For government-backed loans like FHA, a score as low as 580 might be accepted. A higher credit score signals lower risk to lenders.

The debt-to-income (DTI) ratio represents the percentage of a borrower’s gross monthly income that goes towards debt payments. Lenders generally prefer a DTI of 43% or lower, though some may accept up to 50%. A lower DTI indicates sufficient income to comfortably manage the new mortgage payment.

The loan-to-value (LTV) ratio is calculated by dividing the new loan amount by the home’s appraised value. For conventional cash-out refinances on a primary residence, lenders typically cap the LTV at 80%, requiring the homeowner to retain at least 20% equity. Government-backed loans, such as VA cash-out refinances, may allow a higher LTV, potentially up to 100% for eligible veterans. Investment properties generally face stricter LTV limits, often around 70-75%, reflecting increased risk. Many lenders also require a “seasoning” period, meaning the borrower must have owned the property for six to twelve months before eligibility.

The Cash-Out Refinance Process

Initiating a cash-out refinance begins with selecting a lender and submitting an application. This includes financial documents like income verification, tax returns, and bank statements. Shopping around with multiple lenders is advisable to compare interest rates and closing costs.

Once submitted, the application moves to underwriting. Underwriters review documentation to determine if the borrower meets eligibility criteria. This stage involves analyzing credit history, employment stability, and debt-to-income ratio to ensure repayment capacity. The underwriting phase typically takes several weeks.

A home appraisal is a step where an independent appraiser evaluates the property’s current market value. This valuation determines the maximum loan amount based on the lender’s loan-to-value (LTV) limits. The appraisal confirms the property has sufficient equity to support the desired cash-out amount.

Upon successful underwriting and appraisal, the loan moves to closing. The borrower signs legal documents, including the new mortgage agreement and promissory note. Closing costs, typically 2% to 5% of the new loan amount, are paid at this time. These can include origination fees, title insurance, and appraisal fees. After documents are finalized, cash proceeds are disbursed to the borrower, usually within a few business days.

Applying Funds to a New Property Purchase

Upon the successful closing of a cash-out refinance, the borrower receives the cash proceeds as a lump sum. These funds are typically wired directly to the borrower’s bank account, making them readily accessible for various real estate endeavors.

The most common application of these funds for a new property is to cover a down payment. A homeowner can use the cash to make a significant down payment on a second home, vacation property, or an investment property. This reduces the amount needing to be financed through a new mortgage on that property, which can help secure more favorable loan terms or reduce monthly payments.

Beyond down payments, the cash can also be used to cover closing costs associated with the new property purchase, which can range from 2% to 5% of the purchase price. If the new property requires immediate repairs or renovations, particularly for an investment property aimed at generating rental income or increasing value, the cash-out funds can be allocated for these improvements.

When using cash-out funds for a new property, it is important to distinguish between acquiring a primary residence versus an investment property. Lenders view investment properties as having higher risk, often requiring larger down payments (15% to 25% or more) and potentially higher interest rates on the subsequent mortgage.

While the cash received from a cash-out refinance is not considered taxable income by the IRS because it is a loan, not earnings, the deductibility of interest on the refinanced mortgage is generally limited. Interest on the cash-out portion is typically only tax-deductible if the funds are used for substantial home improvements on the original property, not for the purchase of a new property.