Three Types of Mortgage Refinancing

Here’s a quick review of how mortgage refinancing works before jumping into the details of three different types you might consider. Refinancing is when someone with one loan—in this case a mortgage—takes out a second loan to pay off the first one, usually because they can pay less interest on that second loan or secure other loan conditions that save them money. For mortgages, those conditions can be the interest rate, loan length (i.e. term), and amount borrowed.

Three types of mortgage refinance options to know about are rate-and-term, cash-out, and cash-in. If you’re considering refinancing a mortgage, which type is best for you will depend on your individual financial and life circumstances.

Rate-and-term refinance

With a rate-and-term refinance—surprise, surprise!—the two aspects of the new loan that change are the interest rate and the term, or both.

For example, you could refinance from a 30-year fixed rate mortgage into a 15-year fixed rate mortgage; or from a 15-year fixed rate mortgage at 7 percent to a 30-year mortgage at 3 percent interest. While not endless, the combinations are many depending on current interest rates and how they differ from the one you initially secured with your first mortgage.

Rate-and-term refinances allow you to add the closing costs into the loan balance, so you won’t be required to pony up that cash out-of-pocket.

Cash-out refinance

A cash-out mortgage refinance is only available when the home is worth more than what is still owed on the existing mortgage. Choosing this option means taking out a larger second loan (by 5% or more), paying off the first mortgage, and pocketing the difference as cash at closing.

Someone would choose this type of mortgage if they needed a large amount of cash for another expense and felt they could afford the new loan payments. Even though the new mortgage is for a larger amount, the monthly payments may not be much, if any, bigger if the new mortgage has a lower interest rate. In order to secure a better rate, be sure not to exceed a 60% LTV (loan-to-value) ratio—your home’s value vs. what you owe. The loan term can also be changed with a cash-out refinance if you don’t want to restart the amortization clock.

Because cash-out refinancing is a bigger risk for the lender than a rate-and-term refinance, it carries stricter approval standards. You may need a higher credit score, for example.

Cash-in refinance

This is the opposite of a cash-out refinance. With this option, you would bring cash to the closing to pay down the loan balance owed to the lender. The appeal of a cash-in refinance is the chance for a lower mortgage rate, a shorter term, or both.

You might choose a cash-in if you want to take advantage of a lower interest rate but need to lower your LTV ratio first. It also allows you to hit the 20% equity bar in your home, which means you stop paying private mortgage insurance (PMI) and ultimately save money.

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