The Ultimate Guide to Cash Out Refinancing: Unlocking the Hidden Equity in Your Home

Refinancing your home can be a useful way of getting a better deal on your mortgage. Sometimes, though, borrowers want more than just to change providers and instead will opt to get some of their equity back as well through cash out refinancing.

In this guide, we look at everything you need to know about cash out refinancing and the ways it might be beneficial for you.

Cash out refinancing is when you refinance your home loan to a larger amount and take out a portion of the equity you’ve built up over time as ‘cash’. This means that you could have access to a large pool of funds depending on how far through your home loan you are.

Now a cash-out refinance means taking out a brand new mortgage with a higher loan amount, so you’d really only be able to do this if you had your property long enough to build equity (or your property rose in value). Conversely, a home equity loan is a second mortgage that doesn’t replace your existing mortgage and usually comes with a fixed rate of interest.

It's also worth noting that cash out refinancing is not a cashback offer. A cash back offer is when the bank offers to give you money when you refinance with them. Cash out refinancing is about accessing funds from within your newly refinanced loan.

So as mentioned, a cash out refinance utilises a portion of your equity. But how does this work in practice? 

Say you find a property valued at $1,000,000: you decide to buy it and your initial deposit is 20% of the value at $200,000. This means you have a loan-to-value ratio (LVR) of 80% and the bank gives you a $800,000 loan to make the purchase. Then, after a period of time you've improved your equity position. For example, say you've contributed another $200,000 to your loan which raises your equity to $400,000. As a result, you could refinance to a better loan because you've improved your LVR to 60% (a better LVR can often allow you a smaller interest rate, too!). 

Now, let’s say you wanted to get an investment property, and you need a deposit of $200,000. By going ahead with a cash out refinance, in particular, you’d be able to access that money relatively quickly. The extra funds could be put into an offset account, bank account or as a line of credit, for example.

But just remember that in this scenario, your refinanced home loan would likely end up being larger. 

Cash out refinance can be a good way of not only improving your home loan through refinancing, but it can also give you access to a large sum of your home equity. Mostly, cash out refinancing is good for purchases that may otherwise take too much time to save for (say, a medical emergency).

You could also use a cash out refinance to help you get out-of-control debt under control. But no matter the situation, this type of refinancing would only suit a borrower in a solid, long-term position with equity built up and some financial know-how. 

We should call out here that all refinancing is usually done for the simple reason that it can help you get a better loan and improve your financial situation. For example, if you refinanced your current home loan, you might be in a position to secure a better rate of interest - maybe 4% instead of 5%. That's typically why people refinance - to get a better rate of interest or even reduce the length (term) of their loan.

With this said, other circumstances like requiring some spare funds might lead you to consider refinancing options such as a cash out refinance loan.

Some of the things that people might usually spend their cash out on are:

• Paying off high interest debt (i.e. credit cards)
• A second home deposit 
• Medical emergencies
• Home Renovations

One of the main downsides of cash out refinance is that you’ll be taking a lot of the equity that you built up over time from paying off your loan, effectively resetting it. So if you already find yourself struggling with your regular repayments, then a cash out refinance could make the situation worse as you’ll be stuck with the loan for longer.

Another drawback to cash out refinancing is accessibility—if you don’t have a good credit history or enough equity in your home, you might not be able to even get approval for a cash out refinance. 

You should also keep in mind that there are generally a couple of fees and charges that are associated with refinancing. This includes fees such as a discharge fee, application fees, and you may have to pay stamp duty again. 

It should also be said that this type of refinancing home loan isn't available with all lenders and where it is, the rules can be very tight. 

Cash out refinancing mostly works well for borrowers who plan to have their home loan for the long term and can afford it. Borrowers who take a cash out refinance should also have some know-how with their money and a good sense of how to manage this level of financial flexibility. 

It’s important to make sure that cash out refinancing makes sense for your situation. For some, it could make their financial position more precarious. However, if you find yourself with your loan for the long term, and want to try and improve your situation, cash refinancing might work for you. As mentioned, it might actually improve your current home loan arrangement, possibly giving you a loan that has a better interest rate, lower or indeed no fees, and extra features like extra repayments and offset accounts.

One of the first things to look for in a cash out refinance is that the bank you’re refinancing to actually has a cash out option. Provided that they do, you should make sure that you:

• You can still make your repayments for your refinanced loan.
• Plan what you’re spending your cash out on as the temptation to spend it all could be strong if you don’t have a concrete plan for it.
• Compare home loans so that you refinance to a home loan that has a good interest rate, low or no fees, and useful features like extra repayments and offset accounts.

Also, it might be a good idea to double check if what you want to do with a cash out refinance can be achieved by some other method. For instance, some home loan providers offer ‘extra’ cash for refinancing with them, although this tends to be about $3,000-$4,000.

Provided you’ve made the decision for a cash out refinance and you know who you’re going to refinance with, you’ll have to go through the home loan application process. 

Also, you’ll need to inform your current home loan provider so that you can get the necessary documentation to refinance your loan.