Make an Informed Decision and Choose the Right Refinance Option for You
With interest rates currently dropping, demand for refinancing is now 37% higher than this time last year when mortgage rates were exactly the same. There’s no wonder why so many homeowners are starting to consider their refinancing options with the Fed hinting at more interest rate cuts before the end of 2024. Two popular refinancing options – rate-and-term refinance and cash-out refinance – both offer unique benefits depending on your financial goals.
This guide will cover the ins-and-outs of both rate-and-term refinance and cash-out refinance to help you understand the key differences between these two refinancing options.
What Is a Rate-and-Term Refinance?
A rate-and-term refinance is one mortgage refinancing option that focuses on changing the interest rate, loan term, or both, without changing the principal balance of the loan. Homeowners typically use this option to secure a lower interest rate, reduce monthly payments, or switch from an adjustable-rate mortgage to a fixed-rate mortgage, or vice versa.
Compared to a cash-out refinance, a rate-and-term refinance doesn’t allow you to withdraw any equity from the home in cash. This makes it a solid choice for those who want to improve their loan terms without increasing their mortgage debt. This refinancing option can help you save significantly on mortgage payments over the life of the loan, depending on the new rate and term.
Why Get a Rate and Term Refinance?
A rate-and-term refinance can be a smart financial move for homeowners who want to improve their mortgage terms and save money over time. It’s generally a popular option because it allows you to change key aspects of your loan without increasing your debt.
Here are some of the key benefits of getting a rate-and-term refinance:
- Lower your interest rate: Reducing your rate can help you save a lot on interest payments over the life of the loan.
- Reduce your monthly payments: Lowering the interest rate or extending the loan term allows you to decrease your monthly mortgage payments.
- Shorten your loan term: If your goal is to pay off your mortgage faster, you can reduce the term of your loan. For example, you can change your 30-year mortgage to a 15-year mortgage.
- Switch loan types: You can switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage for more predictable payments, or vice versa.
- Improve financial stability: Refinancing to better terms can provide more stability and financial control, especially if you secure a fixed-rate loan when interest rates are low.
What Is a Cash-Out Refinance?
A cash-out refinance is another mortgage refinancing option that allows homeowners to replace their current mortgage with a new, larger loan, while taking the difference as cash. This could be a good option for homeowners with significant home equity who want to access cash for other purposes like renovations, debt consolidation, or any other major expenses.
With a cash-out refinance, the homeowner borrows more than what’s owed on the existing mortgage, with the extra amount paid out in cash at closing. Even though this increases the overall mortgage debt, it can provide you with cash relatively quickly while still reaping the benefits of potentially lower interest rates compared to other loan options.
Why Get a Cash-Out Refinance?
A cash-out refinance can be a great financial tool for homeowners looking to access the equity built up in their property while also refinancing their mortgage. This option is a good choice for those who need liquidity and can benefit from potentially lower interest rates.
Here are some reasons to consider a cash-out refinance:
- Fund renovations or repairs: Use the cash to make renovations or upgrades that can increase your home’s value.
- Consolidate high-interest debt: Pay off high-interest credit card debt or personal loans with the cash to lower your overall interest costs.
- Access cash for major expenses: Cover large expenses such as college tuition or medical bills without taking out a separate loan.
- Take advantage of lower interest rates: You can refinance into a lower-rate mortgage while pulling out cash to save on interest compared to other types of loans.
- Build a safety net: Create a cash reserve for emergencies or future investment opportunities.
Key Differences Between Rate-and-Term Refinance and Cash-Out Refinance
The key difference between a rate-and-term refinance and a cash-out refinance is what they’re used for. A rate-and-term refinance is mainly used to change the interest rate or loan term to lower monthly payments or shorten the loan. Homeowners choose this option to reduce their interest costs or switch loan types without increasing their mortgage balance.
On the other hand, a cash-out refinance allows homeowners to access the equity built up in their home in cash by refinancing for a larger loan amount.
The original loan balance is usually kept the same for a rate-and-term refinance, making it ideal for homeowners who want to improve their loan terms without increasing debt. While a cash-out refinance increases the loan amount since homeowners are borrowing additional funds based on their home’s equity.
Interest rates for rate-and-term refinances tend to be lower than those for cash-out refinances, since an increased loan balance can be seen as higher risk to some lenders. Closing costs and fees for both options are fairly similar, typically ranging from 2% to 5% of the loan amount. However, keep in mind that cash-out refinances may include additional fees because of the higher loan value and potential complexity of the loan.
When to Choose Rate-and-Term Refinance
Here are some scenarios where this type of refinance makes sense:
- Interest rates have dropped: If market interest rates have fallen since you first took out your mortgage, refinancing to a lower rate can reduce your monthly payments and save you thousands in interest over the life of the loan.
- Improved financial situation: If your credit score or financial stability has improved, you may qualify for better loan terms, such as a lower interest rate.
- Wanting to pay off the mortgage sooner: Homeowners who want to pay off their mortgage faster may choose a shorter loan term, such as switching from a 30-year to a 15-year mortgage, to become debt-free more quickly.
Benefits:
- Lower monthly payments: Refinancing to a lower interest rate can reduce your monthly mortgage payments, which can improve your cash flow and financial flexibility.
- Shorter loan terms: Refinancing to a shorter term allows you to pay off your mortgage faster and save on interest in the long run.
Considerations:
- Stabilize your mortgage: If you’re looking to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage, a rate-and-term refinance can provide the stability of predictable monthly payments.
- Save on interest without reducing equity: Homeowners who want to save on interest but aren’t interested in tapping into their equity will benefit from a rate-and-term refinance. It provides more favorable terms without increasing overall debt or changing equity.
When to Choose Cash-Out Refinance
Here are some ideal scenarios where a cash-out refinance may be beneficial:
- Need for cash for significant expenses: Whether it’s home renovations or a large upcoming expense, a cash-out refinance allows you to convert a portion of your home’s equity into cash to cover a wide variety of expenses.
- Debt consolidation: If you have high-interest debt, such as credit cards or personal loans, a cash-out refinance can help you consolidate that debt into your mortgage at a lower interest rate to reduce overall payments.
- Leveraging equity for investment: Some homeowners use a cash-out refinance to access funds for new investment opportunities, such as purchasing rental properties or funding a new business venture.
Benefits:
- Accessing cash immediately: A cash-out refinance allows you to access your home equity relatively quickly while keeping your interest low compared to other types of loans.
- Securing better loan terms: In some cases, you can improve your interest rate and loan terms while also pulling out cash, meeting two different needs with one solution.
Considerations:
- Increasing mortgage debt: Remember, a cash-out refinance increases the total amount of your mortgage, which could lead to higher monthly payments and spending more throughout the life of the loan. Make sure that you’ll be able to pay this off in the long-term. Mismanaging your cash-out funds could put your home at risk if you can’t keep up with the larger mortgage payments – you don’t want that.
Rate-and-Term vs Cash-Out Refinance FAQs:
1. What is a rate-and-term refinance?
A rate-and-term refinance is a new loan that replaces your existing mortgage with a new one that has different terms, usually to get a better interest rate or change the length of the loan. The loan balance remains the same, meaning you won’t be able to pull out any cash from the home’s equity.
2. What is a cash-out refinance?
A cash-out refinance is a new, larger loan that replaces your existing mortgage and the difference between the balance on the new mortgage vs. the old one is given to you in cash. This refinance option allows you to unlock your built-up home equity and use the cash for other purposes. If you’re in need of a cash-out lender, check this out.
3. How do I decide between rate-and-term refinance and cash-out refinance?
The choice between rate and term refinance and cash-out refinance depends on your financial goals. For example, it makes sense to choose a rate-and-term refinance if you want to lower your interest rate or change your loan term, while a cash-out refinance is better if you need access to cash.
4. Does a cash-out refinance increase my mortgage debt?
Yes, a cash-out refinance increases your mortgage debt because you are borrowing extra money based on your home’s equity.
5. Will a rate-and-term refinance affect my home equity?
A rate-and-term refinance typically doesn’t affect your home equity directly because you’re not withdrawing any cash from it – you’re just changing the loan terms.
6. Which refinance option typically offers lower interest rates?
Usually, a rate-and-term refinance offers lower interest rates because you’re not borrowing extra cash on top of your original loan amount.
7. What are the closing costs for each refinancing option?
Closing costs for both rate and term refinance and cash-out refinance are generally similar, ranging from 2% to 5% of the loan amount. These costs include appraisal, title, and origination fees.
8. Can I use a cash-out refinance for anything I want?
Yes, you can use a cash-out refinance for anything you want, such as home improvements, debt consolidation, investing, paying for your kids college, etc.
9. How long does it take to break even on refinancing costs?
The time it takes to break even on refinancing costs depends on your monthly savings and the total closing costs, usually ranging from 2 to 5 years, but this can vary depending on the person and their situation. Personal finances are in fact, personal.
10. Can I switch from a fixed-rate to an adjustable-rate mortgage with either refinance option?
Yes, with either a rate and term refinance or a cash-out refinance, you can switch from a fixed-rate mortgage to an adjustable-rate mortgage, or vice versa, depending on your refinancing goals. Speak with your lender about your options.
