How a cash-out refinance actually works
You replace your whole mortgage with a bigger one and pocket the difference.
- The new loan pays off your old balance. You take the extra as cash.
- It is a brand-new first mortgage, so the new rate applies to your entire balance.
- You restart the clock with a new term, and you pay full closing costs.
- Lenders cap your cash by combined loan-to-value, often up to about 80%.
- The catch: if you hold a low rate, refinancing re-prices your whole mortgage at today's higher rate.
The mechanism, in plain terms
A cash-out refinance does not add a loan on top of your mortgage. It swaps your mortgage for a new, larger one.
Say you owe $200,000 and your home is worth $400,000. You take out a new mortgage for $260,000. That new loan pays off the old $200,000. You walk away with the $60,000 difference in cash.
Here is the part that matters most. The new loan is a whole new first mortgage. So the new rate applies to the entire balance, not only the cash you pulled. You are re-pricing all $260,000, not the $60,000.
You also restart the clock. A new 30-year term resets your payoff date, and you pay a full set of closing costs, often 2% to 5% of the loan.
The steps
- You apply for a new, larger mortgage. The lender checks your income, credit, and home value, the same way a first mortgage works.
- The lender caps the size by loan-to-value. Combined loan-to-value is your total mortgage debt divided by the home's value. Most lenders cap it around 80%, so some equity must stay in the home.
- The new loan pays off the old one. At closing, the new mortgage clears your old balance. The old loan is gone.
- You take the difference in cash. Whatever is left after the payoff and closing costs comes to you.
- You repay the whole balance at the new rate and term. Your monthly payment now reflects the full new mortgage, priced at today's rate.
Why it can cost more than a second loan
The rate reset is the whole story right now. If your current mortgage rate is low, refinancing to today's higher rate can cost far more than a second mortgage that leaves the first loan alone.
A second mortgage, like a home equity loan or line of credit, sits on top of your current one. It adds a rate on the new money only. Your low first-mortgage rate stays put.
A cash-out refinance does the opposite. It re-prices everything. Trading a 3% rate on $200,000 for a 7% rate on $260,000 can add tens of thousands over the life of the loan. Run both before you choose.
Compare the two paths in cash-out refi vs. a second mortgage, and see the full price in what a cash-out refinance costs.
A cash-out refinance re-prices your whole mortgage, not only the cash you take.
If you hold a low rate, you may be trading it away to reach a little cash. When your first mortgage rate is well below today's, a second mortgage that leaves it alone is often the cheaper path. Model both before you sign.
Fits when
Fits when your current rate is at or above today's rate, you need a large sum, and one loan with one payment is simpler for you than two.
Wrong for you if you hold a low mortgage rate. A second mortgage keeps that rate and prices only the new money. Check it first.