An equity take-out refinance, also known as a cash-out refinance, allows qualified homeowners to turn their home’s equity into cash for their personal use, such as making home renovations or paying down high-interest debt.
While an equity take-out refinance can be an ideal option for some, it’s important to understand the process, costs and potential drawbacks associated with this type of refinance before moving ahead.
How Equity Take-Out Refinancing Works
As with any type of mortgage refinance, an equity take-out refinance involves replacing your existing mortgage with a new mortgage.
When you apply for an equity take-out refinance, though, you apply for a higher mortgage amount than what you owe on your current mortgage. If approved, you can use that new mortgage to replace your existing mortgage – and pocket the difference in value as cash.
Most lenders allow qualified homeowners to borrow up to 80% of their home’s value, but you’ll need to have greater than 20% equity in your home. Lenders will also look at your credit score and debt service ratio (DSR) when reviewing your application.
As an example, let’s say your home is worth $400,000 and you have $300,000 of principal remaining on your current mortgage. If you wanted to borrow the full 80% of your home’s value, you could refinance into a new mortgage of $320,000. After paying off your existing mortgage with your new mortgage, you’d be left with $20,000 in cash.
Homeowners can gain equity in their home by making regular payments, as well as through their home’s appreciation. If you want to avoid breaking your mortgage contract and paying a penalty, it’s best to wait to refinance until the end of your mortgage term (or its maturity date).
Best Uses For An Equity Take-Out Refinance
The cash you take out with a refinance can be put toward various types of expenses. Common ways homeowners use their equity include:
- Financing home improvements: The cash you get from an equity take-out refinance can be used to pay for expensive home improvements and renovations that could further raise your home’s value. Kitchen remodeling, landscaping projects and new appliances are a few popular uses.
- Consolidating high-interest debt: If you have a substantial amount of credit card or other high-interest debt, you can use the cash from refinancing to consolidate your debt. Done properly, debt consolidation can save borrowers money on interest and help streamline debt repayment.
- Starting up a small business: Small business owners can use cash from their refinance for business expenses or startup costs. An equity take-out refinance typically comes with better interest rates than borrowers would get on a small business or personal loan.
- Investing in stocks or real estate: You can put cash from a refinance into investments, or put it toward purchasing and repairing real estate properties. Investing with cash from a refinance can be risky, though, since you can’t know whether you’ll see positive or negative returns on your investments.
- Affording higher education tuition: You can also use your cash to finance education in the pursuit of new skills or certifications. Depending on tuition costs, you may need to pay for some of your education out of pocket – or secure another source of funding.
Alternatives To Equity Take-Out Refinancing
There are ways other than refinancing to get cash for your project, expense or investments. Take a look at these alternative financing options.
Home Equity Loan
Another way to tap into your home’s equity for cash is to take out a home equity loan. As with an equity take-out refinance, you can use this loan to borrow up to 80% of your home’s value, minus your current mortgage balance. Approved borrowers will receive their funds in a lump sum and repay the loan through fixed monthly payments. Since your home secures the loan, your lender has the right to repossess your property should you miss or stop making payments.
Unlike an equity take-out refinance, a home equity loan is a second mortgage, meaning it’s separate from your primary mortgage and will be an additional debt for you to pay off. Interest rates tend to be higher for home equity loans than equity take-out refinances.
HELOC
Homeowners can also take out a home equity line of credit (HELOC) using their home’s equity. This loan acts similarly to a credit card where you’re approved for a certain amount of credit to withdraw from and repay as you go. HELOCs can either be combined with a mortgage or be standalone credit, and payments will be subject to variable rates.
As with a home equity loan, you risk losing your home if you’re late on too many payments.
Reverse Mortgage
Intended for older homeowners (generally over the age of 55), a reverse mortgage lets you turn up to 55% of your home’s accumulated value into cash for your personal usage. This money is tax-free and won’t affect your eligibility for receiving Old Age Security (OAS) or Guaranteed Income Supplement (GIS) benefits. Funds can be delivered as a lump sum, in regular payments or through ad hoc draws.
Interest rates on reverse mortgages tend to be higher than rates on home equity loans, HELOCs or equity take-out refinances. There are also numerous fees associated with getting a reverse mortgage, in addition to closing costs.
Requirements For An Equity Take-Out Refinance
To qualify for an equity take-out refinance, you’ll have to meet your lender’s requirements for a mortgage. This means having a strong credit score and DSR, as well as proof you have reliable income.
Though requirements can vary between mortgage lenders, you should have:
- Greater than 20% equity in your home
- A credit score of at least 500 – 650
- Generally speaking, a gross debt servicing (GDS) ratio and a total debt servicing (TDS) ratio of under 50% each
- Documented proof of identification, employment and income
Most lenders will also order an appraisal to determine the value of your home, and you’ll likely be required to retake the mortgage stress test.
Equity Take-Out Refinancing Pros And Cons
An equity take-out refinance can be a great option for some, but borrowers should understand the potential disadvantages as well.
Benefits
- You can borrow larger amounts of money than with some other loan options.
- You could get a lower interest rate than you would using an unsecured loan.
- You can use the proceeds to fund home improvements or to consolidate high-interest debt and save on money spent on interest.
Drawbacks
- You could pay a higher interest rate by borrowing more money.
- Your home could go into foreclosure if you default on your new mortgage.
- You’ll have to pay closing costs, as well as other costs related to refinancing.
How To Get An Equity Take-Out Refinance In Canada
Applying for an equity take-out refinance involves many of the steps you complete when you first apply for a mortgage. That said, there are some additional considerations along the way:
- Check your qualifications. The first step is to make sure you’ve built up more than 20% equity in your home. From there, you’ll want to determine whether your credit score and DSR are likely sufficient to qualify for the refinance.
- Figure out how much cash you need. Next, estimate how much cash you need to achieve whatever goal you’ve set for refinancing. If you need more than a refinance will allow, you’ll need to make a plan for supplemental funding. Or, if it turns out you need a much smaller amount of cash than expected, you may consider an alternative like a personal loan.
- Calculate how much you can take out. First, estimate the current value of your home. Next, multiply that number by the percentage of your home’s value you intend to borrow (up to 80%), expressed as a decimal. Finally, subtract your remaining mortgage balance from the result to determine how much cash you may be able to take out. Let’s look again at the example above:
$400,000 x .80 – $300,000 = $20,000 cash from refinancing
In this scenario, your estimated home value is $400,000, and you intend to borrow 80% of your home’s value ($320,000). After subtracting your current mortgage balance of $300,000, you’d be left with $20,000 cash from a refinance.
- Assess your lender options. You could refinance with your current lender, but shop around to make sure you’re not missing a better deal somewhere else.
- Submit an application. After you’ve chosen a lender, fill out an application. Be sure to include all the necessary documents for income, employment, et cetera.
- Complete remaining refinance requirements. As mentioned, you’ll likely need to go through a mortgage stress test and have an appraisal done when refinancing your mortgage. The results of your each test could affect your refinance approval.
- If approved, receive your new mortgage and cash. Once you’ve closed on the new mortgage and paid off the old one, you can use the leftover cash for its planned purpose. Make sure you keep up with your new repayment schedule and amounts, or you risk defaulting on the mortgage.
The Bottom Line
An equity take-out refinance, or cash-out refinance, can get you some extra cash and a new mortgage at the same time. It could be worth pursuing if you can get the amount you need and a good interest rate. However, the costs to refinance can be expensive, especially if you break your current mortgage contract. If you have questions about refinancing and whether it might be a good option for you, consider speaking with a licensed mortgage broker, like one the experts at Rocket Mortgage Canada, UL (Rocket Mortgage™).
If you’re ready to refinance, start the process today with Rocket Mortgage™.