Refinance guide rate-and-term refinance vs cash-out

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Rate-and-Term Refinance vs Cash-Out Refinance: What Homeowners Should Know

Refinancing a mortgage can lower your interest rate, shorten your loan term, or free up cash from your home’s equity. The two main refinance types homeowners consider are rate-and-term refinances and cash-out refinances. Understanding the differences, costs, and common pitfalls will help you choose the right path for your financial goals.

What each option is and when it makes sense

Rate-and-term refinance

A rate-and-term refinance replaces your existing mortgage with a new loan to change the interest rate, the loan term, or both—without significantly increasing the principal balance. Most people use this to lower monthly payments, shorten the loan term (e.g., 30-year to 15-year) to save interest, or switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage.

It makes sense when:

  • Your current interest rate is meaningfully higher than available rates (commonly 0.5%–1% or more).
  • You want to move to a shorter term to save interest and you can afford slightly higher payments.
  • You’re moving from an ARM to a fixed-rate loan to reduce future rate risk.

Cash-out refinance

A cash-out refinance replaces your existing mortgage with a new, larger loan and gives you the difference between the two loans in cash. Homeowners use cash-out to consolidate debt, fund home improvements, pay for education, or invest, but it increases your mortgage balance and reduces home equity.

It makes sense when:

  • You need a large sum of money and prefer a lower interest rate than alternatives (like credit cards).
  • Your home has sufficient equity and loan programs allow the desired cash amount.
  • You can comfortably afford potentially higher monthly payments and the long-term cost of borrowing against your home.

Benefits and drawbacks

Rate-and-term refinance — benefits

  • Lower monthly payments or total interest costs.
  • Ability to switch loan type (ARM to fixed) for stability.
  • No increase in loan principal (keeps equity intact).

Rate-and-term refinance — drawbacks

  • Closing costs and fees still apply.
  • May reset the amortization schedule, extending the time to build equity if you move to a longer term.

Cash-out refinance — benefits

  • Access to substantial cash at mortgage rates, often lower than unsecured loans.
  • Single loan payment can simplify debt consolidation.
  • Funds can be used for home improvements that may increase property value.

Cash-out refinance — drawbacks

  • Increases your mortgage balance and reduces home equity.
  • Higher monthly payments and overall interest costs.
  • May trigger mortgage insurance or higher interest rates due to higher loan-to-value (LTV).

Costs and fees

Both refinance types typically incur similar closing costs, which generally range from about 2% to 6% of the new loan amount. Common fees include:

  • Loan origination or application fees
  • Appraisal fee
  • Credit report and underwriting fees
  • Title search, title insurance, and recording fees
  • Prepaid interest, escrow reserves, and property tax/insurance adjustments
  • Discount points (optional) to buy down the interest rate

For cash-out specifically, expect possible additional costs: mortgage insurance if LTV is high, and potentially a slightly higher rate vs a pure rate-and-term because the loan risk increases.

Step-by-step process

1. Assess your goals

Decide whether you’re refinancing to lower rate/term or to take out cash. Run a break-even analysis to compare closing costs against monthly savings and consider long-term costs.

2. Check credit and prepare documents

Obtain your credit score and gather pay stubs, W-2s or 1099s, tax returns, bank statements, and current mortgage statement.

3. Shop lenders and compare offers

Get multiple Loan Estimates. Compare interest rates, APR, points, closing costs, and LTV limits (cash-out LTV caps vary by program—often 80% for conventional loans).

4. Apply and lock a rate

Submit an application to your chosen lender and choose when to lock the rate. Rate locks protect you from market moves for a set period.

5. Appraisal and underwriting

The lender typically orders an appraisal to confirm property value (critical for cash-out where LTV matters). Underwriting verifies income, assets, and title.

6. Closing

Review the Closing Disclosure, verify costs, and sign documents. For cash-out, you’ll receive funds at closing or shortly after via wire or check.

Common pitfalls to avoid

  • Ignoring the break-even point—if you’ll move before recouping closing costs, refinancing may not make sense.
  • Taking too long to shop—different lenders can offer materially different terms and fees.
  • Rolling closing costs into the loan without considering higher long-term interest.
  • Using a cash-out for consumption (vacations, nonessential spending) that increases long-term costs and risk.
  • Failing to account for private mortgage insurance (PMI) that can negate monthly savings if LTV rises above certain thresholds.
  • Resetting the amortization to a new 30-year term without considering it may increase total interest paid over the loan life.

Short FAQ

Q: How much cash can I take out with a cash-out refinance?

A: It depends on the loan program and your credit. Conventional lenders often cap cash-out at 80% LTV, while some government programs allow higher LTV under certain conditions. Lenders will also consider income, credit score, and debts.

Q: Will refinancing lower my interest rate if I take cash out?

A: Not necessarily. Cash-out refinances typically carry a slightly higher interest rate than a rate-and-term refinance because the lender is taking on more risk by increasing the loan balance.

Q: Can I roll closing costs into the new loan?

A: Yes, many lenders allow you to finance closing costs by adding them to the loan balance or increasing the rate in exchange for lender credits. That reduces upfront cash but increases the loan amount and long-term costs.

Q: How long should I wait to refinance again?

A: There’s no mandatory wait, but lenders may have seasoning requirements for cash-out refinances (often six months to a year after purchase). Also consider practical factors like recouping closing costs and market conditions.

Choosing between a rate-and-term refinance and a cash-out refinance depends on your financial priorities—lowering monthly payments and interest vs accessing home equity for immediate needs. Compare offers, understand costs and long-term consequences, and plan how the new loan fits into your overall financial strategy.

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