Patt Jacobsson

Cash-out refinancing lets you take out a new mortgage for more than you owe on your existing one — and keep the difference in cash. The amount you may qualify for depends in part on how much equity you have in your home.

You might use the money to invest in home improvements, consolidate high-interest debts or pay for other pressing needs — but a cash-out refi isn’t always your best option.

We’ll walk through how a cash-out refinance works, when it might make sense to consider and what alternatives you should weigh.

A traditional mortgage refinance and cash-out refi both involve taking out a new loan to pay off your existing mortgage. With a traditional refinance, you borrow about the same amount as you currently owe and try to get a lower interest rate, different term or both.

Your interest rate and term could also change with a cash-out refi, but the idea is to borrow more than you currently owe and use the extra cash for something else.

If you’re just looking to lower your interest rate, a traditional refi may be the better option because it tends to have lower rates than a cash-out refi.

“A cash-out refinance can be a great option if you were already planning to refinance your home loan, and you’ve built up equity in the home,” says Andy Taylor, GM of Mortgage at Credit Karma. “It’s essentially taking out another, larger loan to pay off your original mortgage, and using the extra money borrowed for cash in-hand.”

Generally, the maximum is 80% of your loan-to-value ratio, or LTV. For example, if your home is worth $100,000, you may only be able to borrow a total loan amount of $80,000.

To qualify for a cash-out refinance, you’ll generally need to get your home appraised. The appraisal value may impact how much money you can take out, as it determines the home’s value for the loan-to-value ratio.

After paying off the original mortgage and associated fees, there aren’t usually any restrictions around how you use the money you receive on a cash-out refinance. But consider carefully how you choose to spend it.

“People might regret using the money to splurge on a luxury,” says Rebekah Tardieu, a mortgage loan originator with Cardinal Financial Company in Melville, New York. She suggests “trying to use the money to put yourself in a better financial position.”

If you’ve accumulated equity in your home, it makes sense that you want to tap into it to achieve another financial goal. Here are some situations when you might want to consider a cash-out refinance.

While there may be many reasons you want a cash-out refi, it might not always make sense. Here’s why.

If refinancing won’t lower your interest rate, you may want to consider a home equity line of credit (HELOC) or home equity loan (HEL) instead. These are sometimes called second mortgages, but they won’t replace your mortgage or change your mortgage terms.

A home equity loan gives you a lump-sum payout and uses your home as collateral. A HELOC also uses your home as collateral, but you can borrow money as needed until you’ve maxed out the line of credit or the draw period ends (often 10 years later).

While the interest rate on a home equity loan or HELOC might be higher than what you’d pay on a cash-out refi, you won’t lose your current mortgage rate, and you might not have to pay as much in closing costs. You should crunch the numbers to figure out which option is best for you.

If you think a cash-out refinance is a good possibility for you, make sure to compare mortgage lenders. If you’re shopping for a mortgage, you have a window of time where multiple credit inquiries are only counted as one for your credit scores. You typically have 14 days — though it could be longer depending on the scoring model.

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Jacobson currently serves as the vice president for development and alumni relations at Grinnell College , which is consistently ranked as one of the top 20

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