Getting cash back at closing is exactly what it sounds like – receiving cash at the close of the sale or refinance of your home. To understand why a person might get cash back at closing, you need to understand the concept of equity.
Equity is a measure of how much of your home you own outright, free and clear of any financial encumbrances such as a mortgage. If you paid for your home in cash, you have full equity in your home, equal to the fair market value of your home at that time. Most people don’t pay for their homes in cash, but instead take out a mortgage. If you have taken out a mortgage, the equity you have in your home is equal to the amount of the down payment you have made plus the amount of the mortgage you have paid off (minus interest) plus the amount of any appreciation in the fair market value of the home.
For example, assume Bob Buyer bought a house for $300,000. He put down a $30,000 down payment and took out a mortgage for $270,000. Ten years later, Bob had paid down the mortgage by $15,000 and the value of the house had appreciated to $320,000. At the start, Bob had $30,000 of equity, equal to the amount of his down payment. Ten years later, Bob had $65,000 of equity: $30,000 from the down payment; $20,000 from appreciation; and $15,000 from paying on his mortgage.
It used to be that in order to take advantage of the equity in your home, you had to sell it. These days many property owners are able to take advantage of the equity that they have built up in their property without actually have to sell the property. They usually do this by getting cash back at the closing of a refinance on a home that has greatly appreciated. The cash can come in the form of hard cash or an equity line of credit. Either way, when you get cash back at closing, it is usually structured as a loan secured by the increased equity in your home. Typically, the loan takes second position behind the original mortgage (called a purchase money mortgage), so that in the event of foreclosure the purchase money mortgage is still paid off first. Just like the initial mortgage, the second mortgage decreases the equity in your home until you pay it off.