Your home is one of your greatest investments. As you pay your mortgage, you build home equity. Cash-out refinancing allows you to access the equity in your home and turn it into cash. Even if you haven't fully paid your mortgage, you can still tap into your existing equity and refinance your home.

How does a cash-out refinance work? Learn more about this financing option and whether it might be a good choice for you.

What is a cash-out refinance?

When you refinance your home, you replace your existing mortgage with a new one. Usually, the goal is to replace the loan with a mortgage that offers better refinance interest rates and loan terms. This can save you money over the life of your mortgage loan.

It is similar to a rate and term refinance, which benefits homeowners by allowing them to capitalize on more favorable terms. However, a cash-out refinance allows you to convert a portion of your existing equity into available cash.

The cash-out refinance process

With this financing option, you'll replace your existing home loan with a larger one.

The difference between the two will be the amount of money you can tap into when you "cash out."

Most lenders require you to maintain at least 20% equity in your home after a cash-out refinance.

For example, imagine you own a home valued at $350,000 and your remaining mortgage balance is $50,000. That would mean you have $300,000 in equity. Your lender will expect you to keep at least 20% of that $350,000 valued home, which would be $70,000.

In this example, you can recieve financing for as much as $230,000 ($300,000-$70,000).

Check your lender requirements

Not all lenders will require you to maintain 20% equity in your home, so it's wise to understand the requirements.

This is especially important as it applies to additional fees associated with the process. According to local mortgage lender Janie Arrington with Atlantic Bay Mortgage, these fees can include closing costs, administrative fees, and appraisal costs.

Lenders will also evaluate you, looking at things like your credit score and debt-to-income ratio.

Reasons for a cash-out refinance

Like personal loans, cash-out refinancing can be used for various purposes. For instance, a cash-out can allow you to:

• Complete home improvement projects
• Consolidate debt
• Cover unexpected repairs and expenses
• Invest your cash

While many homeowners choose a cash-out refinance to perform home repairs or remodeling, you have considerable flexibility in allocating the cash you receive. What's more, you can still obtain the potential benefits of a refinance, especially if your credit history has improved since you first secured your mortgage.

A cash-out refinance can allow you to tap into your equity and potentially secure better mortgage rates.

Pros and cons of cash-out refinancing

Is cash-out refinancing right for you? The answer depends on your current financial situation, as well as your broader financial goals.

Pros

Cash-out refinancing can have many advantages. For example, it allows you to do all of the following:

• Potentially obtain lower interest rates than personal loans or other financing options
• Improve your credit score by using loans to pay off existing debt
• Fund home improvement projects or big purchases
• Use the funds for other flexible reasons

Cons

The above-mentioned benefits certainly make cash-out refinancing an attractive option. But before you commit to the process, you should be aware of the drawbacks. For example:

• Your interest rate may go up
• Some lenders charge private mortgage insurance (PMI)
• Your new loan may extend your loan period, locking you into long-term debt
• Tapping into your home's equity won't improve your financial discipline
• The process comes with appraisal fees, closing costs, and other expenses

Furthermore, your monthly mortgage payments will likely increase if you take out a large loan amount. If you can't make these new, higher payments, you risk foreclosure on your home.

Explore your options

As you can see, cash-out refinancing isn't right for everyone. But if you have equity in your home and strong credit, this financing option can be a great way to tap into large, flexible sums of cash. For many homeowners, cash-out refinancing can provide the funding for major life needs. These include renovation projects, paying off debt, and financing major costs like a wedding or college tuition.