Cash-Out Refinance on a Free-And-Clear Property: What to Consider

All major mortgage types allow you to get a cash-out mortgage on a free-and-clear property.

Instead of paying off existing mortgages, the loan proceeds go to you.

This can be a great benefit for those who have paid off a house in the past but now need cash for other purposes. Here’s what to know.

No Restriction on Funds

You can use cash-out funds for any purpose. Most recently, popular uses are consolidating debt and raising cash for real estate and other investments.

But even if you wanted to pay tuition costs upfront, purchase a boat, or even go on vacation, the lender typically has no restrictions on what you use it for.

Qualifying for a Cash-Out Refinance

Having equity in the home is just the first step to qualifying for a cash-out refinance.

The lender will review assets, income, and employment documentation to verify you can repay the loan. General guidelines are as follows.

Debt-to-income (DTI) ratio: under 45%

Maximum LTV: 75-80%

Cash reserves: 2-6% of unpaid balances of all financed properties, depending on number owned

Credit score: 620 minimum; 720+ for the best rates

Payment: This may sound obvious, but you’ll go from no payment to a potentially large payment each month. Make sure you can comfortably cover this new expense even if you experience a disruption in income.

Types of Cash-Out Loans

Conventional: This is the most popular kind. It requires good credit and preferably a low DTI

FHA cash-out: Best for lower credit scores.

VA cash-out: Reserved only for active-duty and former U.S. military servicemembers.

Maximum Loan-To-Value and Loan Limits

For conventional loans, Fannie Mae and Freddie Mac limit how much you can take out of the property.

First, the loan amount must meet local loan limits, which are $766,550 for most of the country in 2024 and higher in some locations.

Next, the loan must meet loan-to-value or LTV limits as follows.

For example, a 1-unit investment home worth $200,000 would be eligible for a loan amount up to $150,000.

FHA and VA loans come with simpler LTV maximums:

• FHA cash out: 80% (no investment properties or second homes)

• VA cash out: 90-100%, depending on lender (no investment properties or second homes)

Consider Rates, Closing Costs, an Escrow Account

First, cash-out mortgage rates are higher than rate-and-term (no-cash) refis. You could pay a 1% higher rate plus one or more mortgage points.

Next, cash-out refinance closing costs can be 2-4% of the loan amount. Make sure the cost is worth the cash you’re getting. If you need just $30,000, for instance, consider a HELOC or another financing source. Paying $7,000 in closing costs for $30,000 is not a good value.

Additionally, some of your loan amount will be used to set up an escrow account. For instance, you’ll pre-pay about 15 months of insurance and three to nine months of property taxes at closing. This could add up to thousands of dollars.

Having taxes and insurance paid through your mortgage may also be annoying for someone who is used to paying these costs themselves.

Cash-Out Refinance Alternatives

Sometimes, a cash-out refinance isn’t the best option for a free-and-clear property.

Reverse mortgage

Consider this loan if you are age 62+, need cash, and don’t want a payment. You can also use it to take cash out as you need or eliminate other debt. You never have a payment as long as you live in the home.

HELOC

A HELOC is a much cheaper financing option with low or no closing costs. You can use, pay down, and re-use a HELOC like a credit card.

Personal loan

While rates are high, some people prefer a personal loan as not to encumber a property with a mortgage.

Waiting Periods

In some cases, you can’t get a cash-out refinance on a mortgage-free property right away.

For conventional loans, you must be on title for six months unless you acquired the property with cash (see next section).

With FHA, you must live in home for 12 months as your primary residence to be eligible for a cash-out loan.

Cashing Out a Property you Purchased with Cash

If you purchased a property 100% in cash, there’s no six-month waiting period. You can borrow up to the maximum LTV limits above immediately via Fannie Mae’s delayed financing rule.

However, your loan amount can’t be higher than the cash outlay for the property, plus closing costs and prepaid items.

If you took out a HELOC or mortgage on the property at any time, then paid it off, you would need to wait until you’ve been on title for six months to be eligible for cash out.

Properties recently listed for sale

You can get a cash-out refinance on a free-and-clear property that was recently listed. It must be taken off the market before loan closing.

Will you cash out your free-and-clear property?

There’s no one right way to get cash from your paid-off property. A cash-out refinance is one great option, but it’s just one.

Consult with a lender if you’re unsure of costs or requirements for your situation.