Is Cash-Out Refinance Taxable?
A cash-out refinance is not taxable. The cash you receive isn’t income; it’s considered a loan.
Cash-out refinancing replaces your existing mortgage with a new home loan. Thus, you do not need to pay taxes on a cash-out refinance.
Is Cash-Out Refinance Tax Deductible?
You might use your cash-out funds for capital improvements on your home (projects that elevate the baseline value of your property). In that case, you can deduct your new mortgage interest from your taxable income.
Cash-Out Refinance That Is Tax Deductible
Tax-deductible projects include:
- Permanent home additions: Examples include building a new bedroom or bathroom or adding a swimming pool to the backyard.
- Home improvements: Examples include upgrading windows or installing a central air conditioning system.
Cash-Out Refinance That Is Not Tax Deductible
Home repairs don’t qualify for a tax deduction—they don’t improve the baseline value of your house. Examples of home repairs include painting a bedroom or replacing a broken window.
If you use cash-out funds toward payments that don’t include capital improvements (like car payments or credit cards), you cannot deduct the interest on your new mortgage. For more information, refer to IRS Publication 936.
It helps to speak with a certified public accountant (CPA) to ensure your home projects qualify for tax deductions. Save your receipts and other relevant documents that illustrate project details.
How Much Can I Cash-Out Refinance?
How much you can cash-out refinance depends on two factors:
- Your financial situation (e.g., loan-to-value ratio, credit profile, etc.)
- The equity your hold on your home
Your lender will determine how much cash you are eligible to receive. Lenders typically require you to maintain a minimum of 20% equity in your home. Thus, 80% is the most you can receive in cash. There are VA cash-out refinancing options available that offer up to 100% financing.
Example of Cash-Out Refinance
Let’s say your home is worth $350,000. You owe $250,000 on your current mortgage, which means you have $100,000 in equity.
Your lender calculates 80% of your home’s value ($350,000). This comes out to $280,000.
The new loan amount ($280,000) pays off your existing loan of $250,000. The amount of leftover equity is $30,000 is the most you can cash-out refinance.
Remember, this cash-out amount is contingent upon your financial background.
What Are Some Tips to Keep in Mind throughout the Cash-Out Refinance Process?
Cash-out refinancing usually comes at lower interest rates and provides access to funds you can use to pay off other debts.
But there are a few things to keep in mind as you navigate through the cash-out refinancing journey:
- Your home is collateral. Carefully think through whether the cash is worth the risk of losing your home.
- Look carefully at your refinancing plan. The new terms may come with a longer payment timeline, which may require you to pay a higher interest rate over the life of the loan. Make sure you’re not paying more interest than your current/initial mortgage plan.
What Is a Cash-Out Refinance?
A cash out refinance is a mortgage refinancing option that allows you to convert your home equity into cash.
How Does a Cash-Out Refinance Work?
Here’s how cash out with refinancing works:
- You take out a new mortgage. This mortgage is larger than your previous mortgage balance. The difference between these two values is paid to you in cash.
- The lender determines how much cash you are eligible to receive based on factors such as LVT (loan-to-value) ratio and your credit profile. Lenders generally require you to maintain at least 20% equity in your home. There are VA cash out refinancing programs that provide up to 100% financing.
- The cash you receive can help you cover funds for home improvement expenses, debt consolidation, and more.
Example
Let’s say:
- Your home is valued at $200,000, and you have a mortgage balance of $100,000. This gives you equity of $100,000.
- You can refinance your $100,000 loan balance for $160,000 and are eligible to receive up to $60,000 in cash.
Is Cash-Out Refinancing a Good Idea?
Cash out refinancing can be a good idea for the following reasons:
- It usually comes with lower interest rates. Using cash to pay off high-interest payments such as credit cards can save you money in the long run.
- It provides access to additional funds and helps pay off other payments or debts.
Keep in mind that there are drawbacks to consider, such as:
- Your home is being used as collateral. Thus, you must carefully consider whether the cash (the amount and what it’s being used towards) is worth the risk of losing your home.
- The new terms of your refinancing plan may entail a longer payment timeline. Make sure you calculate the total interest you’d have to pay over the life of the loan to avoid possibly paying more interest than your initial mortgage plan.
Factors that May Impact Cash-Out Refinancing Time Frame
Here are some reasons why cash out refinancing can take a long time:
- Paperwork: Your lender may require you to provide documentation such as homeownership documents, proof of income, and monthly debt load. The lender may also have you verify personal information.
- Home appraisal: The most time-consuming aspect of refinancing is securing an appraisal. An appraiser will visit your property to inspect its interior and exterior. They will also compare your home to similar properties and provide an appraisal report. When the refinancing demand is high, reserving an appointment can be challenging.
- Low appraised value: If your home appraisal comes in below what you owe on the mortgage, this can delay the process. You may need to recheck the appraisal report or contact your lender for further information/guidance.
- Credit issues: The lower your credit score, the more likely your loan approval process may be delayed. Your lender may seek more information to assess whether you’re eligible for cash-out refinancing.
When Should You Cash Out Refinance
Here are three common reasons why you’d want to do a cash out refinance:
- Home improvements: Over time, upgrades are necessary for your home. The cash you receive from financing can be a great way to fund your home improvements and renovations.
- Student debt: Paying for student loans with a low-interest refinancing mortgage may be more realistic and appealing than applying for a higher-interest student loan. Review the fees and benefits of refinancing to ensure that it costs less than student loans in the long run.
- Debt consolidation: If you have credit card debt, personal loans, and more, consolidating these into a single cash out refinancing loan can be an appealing option. Refinancing them into a mortgage loan with a lower interest rate can offer a more realistic opportunity to pay off your debts. As mentioned above, verify that you won’t pay more interest in the long run via your refinancing loan.
The Pros and Cons of Cash Out Refinancing to Consider
As you consider if and when you should cash out refinance, remember the pros and cons. Understanding these factors will help you ensure you’re making the right move:
Pros:
- You receive access to additional funds. These funds can be used towards home improvement needs or other high-interest debts.
- The refinancing loan generally comes at a low interest rate.
- Your mortgage interest rate may be tax deductible.
Cons:
- It may take longer to pay off your home.
- You may accrue more interest over time.
- Your home is at risk in the event you cannot make your payments or pay off the loan.
