Over the past few years, homeowners have experienced a steady increase in the value of their homes. In fact, a Zillow report shows the typical Phoenix home value increased 27% from the summer of 2020 to the summer of 2021. As a result, homeowners are experiencing a steady increase in home equity, and many are wondering if a cash-out refinance is a good fit.
What is a Cash-Out Refinance?
A cash-out refinance is a type of mortgage refinance that pays off the existing mortgage and creates a brand-new mortgage linked to the increased value of the home. A borrower may receive cash for a portion of the home’s equity, which in this case will be calculated by taking the difference between the new mortgage amount (less closing costs) and the amount owed on the existing mortgage.
This process results in converting your equity into cash and creating a brand-new mortgage, which may have different terms and rates.
How Do I Determine the Home Equity Amount?
The equity you have in your home is equal to the appraised value of your home minus any first or second mortgage, or any other liens you have on your home.
With that said, over time a homeowner will see the equity increase in their home for two reasons:
- The value of the home increases
- The primary mortgage is typically paid down through monthly mortgage payments
For example, let’s assume you purchased a home for $300,000 five years earlier with a 20% down payment of $60,000. You started with a mortgage balance of $240,000 and after five years, you paid the principal of your mortgage down to approximately $215,000. The current appraised value of your home is now $400,000, resulting in a total equity of $185,000.
Current Appraised Value
Current Mortgage Balance
One important thing to note is a lender will not allow the borrower to turn all of the home equity into cash. Very similar to how a lender will require a 10% to 20% down payment to purchase the home, lenders will generally limit cash-out amounts to 80% of the home’s equity.
In part two of our Cash-Out Refinancing series, Chris Peach will walk you through the refinancing process step-by-step. He’ll help you gather all the important financial information you need before applying for your cash-out refinance.
Check out the other posts about cash-out refinance!
Chris “Peach” Petrie is the founder of Money Peach. Money Peach partnered with OneAZ to provide free financial education to members across the state. To learn more about OneAZ’s partnership with Money Peach, click here.