Cash-out versus rate-and-term refinance: start with the purpose

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Start with the purpose, not the rate

A refinance replaces your current mortgage with a new one. That new loan can change your rate, your term, your loan type, or your balance. Because it is a new loan, it also brings new closing costs and, often, a new amortization schedule.

When the goal is clear, the comparison becomes simpler. A homeowner trying to save on interest is measuring something different from a homeowner who needs funds for a new roof. Writing down the goal first keeps the decision anchored to what you actually need.

Definitions

The two refinance types

Rate-and-term refinance

Also called a no-cash-out or limited cash-out refinance, this type replaces your existing first mortgage with a new loan to change the interest rate, the term, or both. The new loan can typically pay off the existing first mortgage and cover closing costs, points, and prepaid items. Under Fannie Mae’s guidelines, any cash you receive at closing is limited to the greater of 1% of the new loan amount or $2,000.

Cash-out refinance

A cash-out refinance replaces your existing mortgage with a larger one. After the old loan and closing costs are paid, you receive the difference. You can use the money for nearly any purpose, but the loan is subject to lower maximum loan-to-value limits, longer ownership requirements, and usually higher pricing than a rate-and-term refinance.

At a glance

Side-by-side comparison

The table below uses Fannie Mae conventional guidelines for a one-unit primary residence as an example. Other programs and lenders differ.

Source: Fannie Mae Selling Guide B2-1.3-02 and B2-1.3-03, and the Fannie Mae Eligibility Matrix. Limits for second homes, investment properties, and multi-unit homes are lower.

Good fit

When a rate-and-term refinance fits

• Lowering the rate

  If market rates are meaningfully below your current rate and you plan to stay long enough to recover the costs.

• Shortening the term

  Moving from a 30-year to a 15-year loan can reduce total interest, though the monthly principal and interest payment is usually higher.

• Trading an ARM for a fixed rate

  Locking in payment stability before an adjustable rate resets.

• Changing loan programs

  For example, refinancing an FHA loan into a conventional loan may remove FHA mortgage insurance, depending on equity and the new loan’s own requirements.

See rate-and-term refinance options for program details.

Good fit

When a cash-out refinance fits

• Home improvements

  Using equity for renovations or repairs, such as a roof replacement or hurricane-resistant windows, can add value and may affect insurance costs.

• Consolidating higher-rate debt

  Replacing high-interest balances with mortgage debt can lower the monthly cost, but it turns unsecured debt into debt secured by your home and can stretch repayment over decades.

• Investing or funding a major expense

  Some owners use equity toward another property, education, or a business. The risk profile of the use matters.

• Building reserves

  Converting equity into cash reserves can add flexibility, at the cost of a larger mortgage balance.

The math

Run the numbers before you decide

Break-even for a rate-and-term refinance

Divide the total cost of the refinance by the monthly savings to estimate how many months it takes to recover the cost. For example, with hypothetical closing costs of $6,000 and a payment that drops by $200 a month, the break-even point is 30 months. If you expect to sell or refinance again before then, the refinance may not pay off.

Break-even is a starting point, not the whole answer. Also compare the total interest over the time you expect to keep the loan, especially if the new loan restarts a 30-year term.

Cash-out versus keeping your first mortgage

If your current rate is lower than today’s rates, a cash-out refinance reprices your entire balance, not just the new cash. A second lien can sometimes cost less overall. Here is a simplified first-year interest comparison using hypothetical rates:

Hypothetical rates for illustration only. Simple interest on the full balance; actual amortized interest, closing costs, and variable HELOC rates will differ.

Program options

FHA and VA refinance options

• FHA cash-out refinance

  Generally allows borrowing up to 80% of the home’s value on an owner-occupied principal residence that you have lived in for at least the past 12 months, with a satisfactory recent payment history.

• FHA streamline refinance

  A reduced-documentation option for refinancing an existing FHA loan into a new FHA loan, typically to lower the rate or payment.

• VA Interest Rate Reduction Refinance Loan (IRRRL)

  Refinances an existing VA loan into a new VA loan. Seasoning rules require at least 210 days from the first payment and six monthly payments, and the costs generally must be recovered within 36 months.

• VA cash-out refinance

  Available to eligible veterans and can refinance a VA or non-VA loan into a VA loan, subject to VA benefit tests and the lender’s limits.

Florida focus

Florida costs and taxes to plan for

Refinancing in Florida comes with state taxes on the new mortgage debt that are not present in every state. Florida charges documentary stamp tax on promissory notes at $0.35 per $100 and a nonrecurring intangible tax of 2 mills, or 0.2%, on new mortgage debt secured by Florida real estate. How much applies to a refinance can depend on how the transaction is structured, so ask for these to be itemized on your Loan Estimate.

Expect other standard costs as well, such as a new appraisal, a lender’s title insurance policy, recording fees, and an escrow cushion for property taxes and insurance.