Rate-and-Term Refinance vs. Cash-Out Refinance

You’ve built equity in your home, made your mortgage payments, watched the market shift, and maybe noticed that your current mortgage no longer fits your life the way it once did. Now you’re wondering: is it time to refinance? And if so, what kind?

These are fair questions, and you’re not alone in asking them. Refinancing can be a good move for some homeowners, but the path forward depends entirely on your goals. Before you decide anything, it helps to understand the two most common refinance options: the rate-and-term refinance and the cash-out refinance.

In this article, we’ll break down the differences between these two refinancing options, when they generally make sense, and other important considerations.

Key Takeaways You’ll Leave With

• A rate-and-term refinance replaces your current mortgage with a new one, focused on improving your interest rate, loan term, or loan type without changing your loan balance significantly.
• A cash-out refinance allows you to borrow more than you currently owe and receive the difference in cash, using your home equity to fund other goals.
• Both options involve closing costs and replacing your existing mortgage.
• Refinancing may not be the right move for everyone. Speak with a mortgage professional to evaluate your options based on your specific situation.

What Is a Rate-and-Term Refinance?

A rate-and-term refinance replaces your existing mortgage with a new one, generally with the goal of improving the terms of your loan: your interest rate, your loan length (term), or both.

Here’s when a rate-and-term refinance might make sense for you:

• Interest rates have dropped since you closed your original loan, and locking in a lower rate could reduce your monthly payment.
• You want to shorten your loan term, say, from 30 years down to 15, to pay off your mortgage faster and potentially save long-term on total interest paid over the life of the loan.
• You have an adjustable-rate mortgage (ARM) and want to move to a fixed-rate mortgage for more predictable monthly payments.
• You want to extend your loan term to lower your monthly payment amount, even if that means paying more interest over time.

In a rate-and-term refinance, your loan balance generally stays about the same (give or take closing costs that may be rolled in). The primary benefit is improving your loan’s structure, not pulling money out of your home’s equity.

What Is a Cash-Out Refinance?

A cash-out refinance also replaces your existing mortgage with a new one, but this time, you borrow more than what you currently owe. The difference between your old loan balance and your new, larger loan amount is paid out to you in cash at closing.

Think of it this way: if your home is worth $400,000 and you owe $200,000, you have $200,000 in equity. With a cash-out refinance, you may be able to borrow against a portion of that equity and receive a lump sum to use toward other financial goals.

Common reasons homeowners consider a cash-out refinance include:

• Funding home improvement projects
• Consolidating high-interest debt, such as credit card balances, into a single monthly mortgage payment at a potentially lower interest rate
• Covering major expenses like tuition, medical costs, or other significant purchases
• Investing in a second property or investment home

It’s important to understand that a cash-out refinance increases your loan balance. You’ll be borrowing more than you currently owe, which means your monthly payment may go up, even if you secure a lower interest rate. It’s a trade-off worth examining carefully.

Rate-and-Term vs. Cash-Out: Key Differences

While both options involve replacing your current mortgage, the primary difference comes down to purpose and loan balance:

• Rate-and-term refinance: Your loan balance stays roughly the same. The goal is a better rate, a shorter or longer term, or a different loan type. No cash is taken out.
• Cash-out refinance: Your loan balance increases. You receive the difference between your new loan amount and what you owed in cash. Your home’s equity decreases.

Lenders also tend to evaluate these two options differently. Cash-out refinances often come with stricter qualification requirements, such as higher credit score thresholds or lower loan-to-value (LTV) ratios, because they represent a greater lending risk.

A Few More Things to Consider Before You Refinance

Regardless of which refinance option you’re leaning toward, there are some universal factors that will affect whether refinancing makes sense for your situation:

• Closing costs: Refinancing comes with closing costs. You’ll want to calculate your break-even point. That means figuring out how long it will take for your savings to offset those upfront costs.
• How long you plan to stay: The longer you remain in your home after refinancing, the more opportunity you have to realize the benefits. If you’re planning to move in a few years, refinancing may not make sense.
• Your credit profile: Your credit score, debt-to-income ratio, and overall financial health will influence the rates and terms you’re offered.
• Current market rates: Refinancing makes the most sense when the new rate is meaningfully lower than your existing one or when the terms offer a clear advantage for your long-term goals.

Final Thoughts

Refinancing your mortgage is a significant financial decision, and it doesn’t come with a one-size-fits-all answer. Whether you’re drawn to a rate-and-term refinance to improve your loan’s structure or a cash-out refinance to put your equity to work, what matters most is that you’re making the choice that aligns with where you are today and where you’re headed.

Understanding the difference between these two refinance options is a great first step. The next step is having a real conversation about your numbers, your goals, and what the current market may mean for you.