Are Cash-Out Refinance Rates Higher?

Are Cash-Out Refinance Rates Higher?

A cash-out refinance loan allows you to tap into your home's equity by taking out a larger mortgage and receiving the difference in cash.

However, this benefit comes at a cost. Cash-out refinance rates are typically higher than those for a traditional rate-and-term refinance, which is designed only to change your interest rate, adjust your repayment term or both.

Why Cash-Out Refinance Rates Are Higher

Cash-out refinance loans have higher interest rates because lenders view them as riskier than a traditional refinance. There are a couple of reasons for this:

• Higher loan-to-value ratio (LTV): With a traditional refinance, you're replacing your current loan with a new one without changing your balance. A cash-out refinance, on the other hand, replaces your current loan plus an additional cash amount. A higher LTV translates to a bigger loss for the lender if you default.
• Larger monthly payment: Depending on the original loan's terms and how long you've been paying it down, your new monthly payment may be larger than the old one. That means your debt-to-income ratio (DTI) will be higher, and a higher DTI may increase your risk of defaulting on payments.

Learn more: How Much Does It Cost to Refinance a Mortgage?

How Much Higher Are Cash-Out Refinance Rates?

Cash-out refinance rates are typically 0.125% to 0.25% higher compared to rate-and-term refinance loans.

What Determines Cash-Out Refinance Rates?

The interest rate you qualify for on a cash-out refinance loan will depend on several factors, including the following:

• Credit score: The minimum credit score for a cash-out refinance may be higher compared to a traditional refinance. It could range from 640 to 700, according to Fannie Mae, the government-sponsored enterprise that buys many U.S. mortgages. However, you may have a higher rate if your score isn't in the mid-to-upper 700s or higher.
• Income: Lenders want to see that your income is sufficient to repay the debt and that it's stable. If you're self-employed or you've recently switched to a different job, it could result in a higher interest rate.
• DTI: Your DTI is calculated by adding up your monthly debt payments and dividing the sum by your gross monthly income. Conventional lenders may be willing to accept a DTI as high as 45%, but the lower it is, the better your odds of getting a better interest rate.
• LTV: Your LTV is your loan amount divided by your home's value. Between your existing mortgage balance and the extra cash you want to take out, the maximum LTV ratio is usually 80%, though some lenders may be willing to go higher. But remember, higher LTVs are riskier for lenders, so they come with higher rates.
• Market conditions: Economic conditions, such as inflation, job growth and overall economic growth, have an impact on the rates lenders offer to all borrowers. During periods of strong economic growth, interest rates tend to be higher. As economic growth slows, interest rates may go down.

Learn more: Compare Current Mortgage Rates

How to Get the Best Cash-Out Refinance Rate

Before you apply for a cash-out refinance loan, it's important to consider the pros and cons, and also put yourself in a good position to secure a low interest rate. Here are some steps you can take:

• Improve your credit score. Start by getting free access to your Experian credit report and FICO^® Score^☉. These resources can help you get a better understanding of your credit profile and provide insights into which actions you can take to improve your credit.
• Maintain a low LTV ratio. Credit score requirements tend to be higher if your LTV is over 75%, so keeping it below that could also potentially help you secure a lower rate. This may mean borrowing less or paying down your mortgage a little more before applying.
• Shop around with multiple lenders. Each lender has its own policy for determining the rates it offers to borrowers. As such, it's crucial that you get preapproved and compare rates and fees from a handful of lenders before moving forward with one.
• Buy discount points. Discount points are a form of prepaid interest that can help reduce your interest rate. One point typically costs 1% of your loan amount and can lower your rate by up to 0.25%. According to Freddie Mac, cash-out refinance borrowers tend to pay more in points than traditional refinance borrowers.
• Lower your DTI. To lower your DTI, you'll need to pay off credit cards and small loan balances in full to remove the payment from your credit history.

Learn more: How to Shop for a Mortgage

Frequently Asked Questions

The Bottom Line

While cash-out refinance loans typically come with higher interest rates, they can still be a smart financial move if used strategically. By understanding how rates are determined and taking steps to strengthen your financial profile, you can improve your chances of securing a favorable deal.

As with any major financial decision, take time to compare offers, weigh the costs and consider your long-term goals before moving forward. It's also important to monitor your credit throughout the process to ensure you remain on the right track.