Refinancing is a great way to lower your monthly mortgage payments and save yourself some serious cash. But did you know that there are actually two types of refinance options available to homeowners? That’s right – and understanding the difference between them could mean the difference between significant savings or disappointment.
The first type of refinance is called a rate and term refinance, and it is the most common form of refinancing. This type of refinance allows you to change the interest rate on your current loan by refinancing for a new loan with a lower interest rate. The goal here is to lower your monthly mortgage payments and potentially save thousands of dollars over the life of your loan.
The second type of refinance is a cash-out refinance. Here, you are taking out a new loan to replace your current mortgage, but you are also borrowing additional money to use for other expenses like home renovations, debt consolidation, or unexpected expenses. This type of refinance allows you to use your home’s equity to get cash in hand, but keep in mind that you will have to potentially pay more in overall interest charges.
Understanding Refinancing
Refinancing is the process of replacing an existing loan with a new one that provides better terms or meets the changing needs of the borrower. It is a practical financial tool that can help homeowners save money on their monthly mortgage payments or cash out the equity in their homes. Refinancing requires careful consideration of the options available and an understanding of its potential benefits and drawbacks.
Two Types of Refinance
- Rate and Term Refinance: This type of refinance involves changing the interest rate or loan term of an existing mortgage. The primary goal is to lower the monthly mortgage payment, reduce the interest rate, or shorten the loan term. Borrowers typically choose this option when they expect to stay in their home for a long time or want to pay off their mortgage faster.
- Cash-Out Refinance: This type of refinance involves borrowing more than the existing mortgage balance and using the difference to pay off debts, make home improvements, or invest in other assets. The primary goal is to turn home equity into cash that can be used for any purpose. Borrowers typically choose this option when they need to access capital or consolidate higher-interest debt.
Factors to Consider
Refinancing can be a beneficial financial move for many homeowners, but it requires careful consideration of several key factors:
- The current interest rate. Refinancing may not make sense if the current interest rate is already low or if the borrower has a variable rate mortgage with favorable terms.
- The new interest rate. Refinancing can be a smart choice if the new interest rate is lower than the existing rate and the borrower plans to keep the property for an extended period.
- The loan term. Choosing a shorter loan term can save money on interest in the long run, but it may result in higher monthly payments.
- The closing costs. Refinancing incurs costs similar to those associated with getting a mortgage from scratch, such as loan origination fees, appraisal fees, and closing costs. These expenses can offset the savings from refinancing.
Conclusion
Refinancing can be a powerful financial tool for homeowners who want to lower their monthly payments, reduce their mortgage term, or access cash from their home equity. Choosing the right type of refinance and carefully considering each factor can help borrowers make the right decision and achieve their financial goals.
| Factors to Consider | Rate and Term Refinance | Cash-Out Refinance |
|---|---|---|
| Goal | Lower monthly payment, reduce interest rate, or shorten loan term | Access equity for cash, home improvements, or debt consolidation |
| Interest Rate | New rate must be lower than existing rate | New rate must be lower or similar to existing rate |
| Loan Term | Choosing a shorter term can save money on interest in the long run but have a higher monthly payment | Choosing a longer term can increase the total interest paid over the life of the loan but can lower monthly payments |
| Closing Costs | Average closing costs range from 2% to 5% of the loan amount | Average closing costs are higher than rate and term refinance due to the cash-out component |
Sources: Bankrate, NerdWallet
Types of Refinancing
Refinancing is essentially taking out a new loan to pay off your current one. This can be a great option for those looking to lower their interest rates, reduce their monthly payments, or consolidate debt. There are two types of refinancing: rate-and-term and cash-out refinancing.
Rate-and-Term Refinancing
- Rate-and-term refinancing is the most common type of refinancing.
- The goal is to get a lower interest rate or change the terms of the loan.
- This type of refinancing typically does not involve borrowing more money than what is currently owed on the loan.
- Borrowers can choose to shorten or lengthen the term of their loan, which can also affect their monthly payments.
Cash-Out Refinancing
Cash-out refinancing involves borrowing more money than what is currently owed on the loan. The difference between the new loan and the old loan, minus any fees, is given to the borrower in cash. This can be a great option for homeowners looking to consolidate debt or make home improvements.
However, it is important to weigh the pros and cons of cash-out refinancing. Borrowers will likely have a higher monthly payment and potentially a longer loan term. In addition, borrowing against the equity in your home can be risky and should be carefully considered.
| Pros | Cons |
|---|---|
| Consolidate debt | Higher monthly payment |
| Lower interest rate | Longer loan term |
| Make home improvements | Risk of borrowing against equity |
Benefits of Refinancing
Refinancing is an option many homeowners consider when looking for ways to improve their finances. The process of refinancing involves replacing an old mortgage with a new one that has better terms. If done correctly, refinancing can improve your financial situation in a multitude of ways. Here are some of the benefits of refinancing:
- Lower Interest Rates: One of the primary reasons people refinance is to take advantage of lower interest rates. If you can secure a lower interest rate on your new mortgage than what you currently have on your old one, you can save money in interest payments over the life of the loan, ultimately freeing up more cash for other expenses.
- Reduce Monthly Payments: With a lower interest rate, you can also reduce your monthly payments. Refinancing enables homeowners to extend the term of their loan, which results in a lower monthly payment.
- Change Loan Type: Homeowners who have adjustable-rate mortgages (ARMs) may consider refinancing into a fixed-rate mortgage (FRM) to lock in a lower rate and avoid future payment increases.
While refinancing can provide significant benefits, keep in mind that there are costs associated with refinancing such as application fees, appraisal fees, and closing costs. Be sure to analyze all of the costs of refinancing before making a final decision.
If you’re ready to explore refinancing options, check with lenders to find the best refinancing rates and terms that work for your financial situation.
The Numbers Behind Refinancing
It’s important to understand the numbers behind refinancing to know whether or not it is a good option for you. Let’s take a look at an example:
| Mortgage Balance: | $200,000 |
|---|---|
| Interest Rate: | 4.5% |
| Term: | 30 years |
| Monthly Payment: | $1,013.37 |
| Total Interest Paid over Term: | $164,813.42 |
In this example, if the homeowner could refinance to a new interest rate of 3.5%, the numbers would look like this:
| Mortgage Balance: | $200,000 |
|---|---|
| Interest Rate: | 3.5% |
| Term: | 30 years |
| Monthly Payment: | $898.09 |
| Total Interest Paid over Term: | $128,849.99 |
As you can see, the interest savings is substantial, with a reduction of over $35,000 over the course of the loan. Additionally, the monthly payment drops by over $100, freeing up additional cash for other expenses.
Remember, these numbers are just an example, and your own situation will differ based on your mortgage balance, interest rate, and loan term. Be sure to do your own calculations to determine the potential benefits of refinancing.
When to Refinance
If you’re considering refinancing your home, it’s important to understand the different types of refinancing available. Two of the most common types of refinancing are rate-and-term refinancing and cash-out refinancing. While both can be beneficial in certain situations, deciding which type to pursue depends on your individual circumstances.
- Rate-and-Term Refinancing: This type of refinancing simply replaces your old mortgage with a new one that has a lower interest rate or better terms. The goal is to lower your monthly payments and reduce the amount you’ll pay in interest over the life of the loan. You might consider rate-and-term refinancing if:
- Your credit score has improved since you took out your original mortgage
- Market interest rates have fallen since you took out your original mortgage
- You want to switch from an adjustable-rate mortgage to a fixed-rate mortgage
- Cash-Out Refinancing: This type of refinancing allows you to borrow against the equity you have built up in your home. When you refinance, you can take out a lump sum of cash that can be used for anything you want, such as paying off debt or making home improvements. You might consider cash-out refinancing if:
- You have a significant amount of equity in your home
- You have high-interest debt that you want to pay off
- You want to make improvements to your home that will increase its value
Deciding when to refinance depends on a variety of factors, such as your current interest rate, loan term, credit score, and financial goals. It’s important to consider the costs associated with refinancing, such as closing costs and fees, and weigh them against the potential benefits. A good rule of thumb is to refinance when interest rates are at least 1% lower than your current rate, but each situation is unique, and you should consult with a financial professional to determine what’s best for you.
| Pros of Rate-and-Term Refinancing | Cons of Rate-and-Term Refinancing |
|---|---|
| Lower monthly payments and interest rates | May not save you a significant amount of money if you’re close to paying off your mortgage |
| Can allow you to switch from an adjustable-rate mortgage to a fixed-rate mortgage | May require you to pay closing costs and fees |
Ultimately, when to refinance depends on your financial goals and individual circumstances. However, by understanding your options and working with a financial professional, you can make an informed decision that puts you on the path to financial success.
Home Equity Loans
When it comes to refinancing, one option to consider is a home equity loan. This type of loan allows you to borrow a predetermined amount of money using your home as collateral. There are two main types of home equity loans:
- Fixed-rate home equity loans: This type of loan offers a fixed interest rate for the entire term, which means your monthly payments will remain the same. This makes budgeting for your loan payments easier.
- Home equity line of credit (HELOC): A HELOC is a flexible loan that allows you to borrow money as needed up to a set limit. Unlike a fixed-rate loan, the interest rate on a HELOC is variable, which means your payments could increase or decrease over time.
One of the biggest advantages of a home equity loan is that the interest you pay on the loan may be tax deductible, making it a popular choice for homeowners who need cash for home improvements or other large expenses. However, keep in mind that if you default on your loan, you risk losing your home.
Before you apply for a home equity loan, it’s important to understand the terms and fees associated with the loan, including any closing costs, annual fees, and prepayment penalties. You’ll also need to have a good credit score and enough equity in your home to qualify for the loan.
| Advantages of Home Equity Loans: | Disadvantages of Home Equity Loans: |
|---|---|
| Lower interest rates than personal loans or credit cards | You risk losing your home if you default on the loan |
| May be tax deductible | Closing costs and other fees can be expensive |
| Flexible loan options | Requires good credit score and enough equity in your home to qualify |
Overall, a home equity loan can be a smart financial move if you need to borrow money for a large expense and have enough equity in your home to qualify. Just make sure you do your research and understand the terms and fees associated with the loan before you sign on the dotted line.
Cash-Out Refinancing
Cash-out refinancing is a type of refinancing where the borrower takes out a new mortgage for more than what is currently owed, with the difference being paid out in cash. There are two types of cash-out refinancing: limited cash-out refinancing and standard cash-out refinancing.
- Limited cash-out refinancing: This type of refinancing allows the borrower to take out up to $2,000 extra cash. However, the loan cannot exceed the current value of the home, and the borrower must use the funds for certain purposes, such as home improvements or paying off debts.
- Standard cash-out refinancing: This type of refinancing allows the borrower to take out more than $2,000 in cash. The borrower can use the funds for any purpose, but the loan cannot exceed a certain percentage of the value of the home.
Cash-out refinancing can be a useful tool for homeowners who have built up equity in their homes and need cash for other expenses, such as home improvements or debt consolidation. However, it is important to remember that refinancing often comes with closing costs and other fees, which can add up quickly. Borrowers should carefully consider the costs and benefits of cash-out refinancing before making a decision.
Rate-and-Term Refinancing
Rate-and-Term Refinancing is a type of refinancing that allows homeowners to change the interest rate and/or term of their existing mortgage without borrowing additional money. The objective of this refinancing option is to secure better terms on your mortgage, which, in turn, results in lower monthly payments and/or less interest paid over the life of the loan.
Here are some of the benefits and considerations of rate-and-term refinancing:
- Lower interest rates: One of the primary reasons homeowners opt for Rate-and-Term Refinancing is to lower their interest rates. With lower interest rates, you can reduce your monthly mortgage payments and save thousands of dollars over the life of the loan.
- Change your loan term: Another advantage of rate-and-term refinancing is that it allows you to change your loan’s term. For instance, if you have a 30-year mortgage and you’ve been making payments for the past 10 years, you may want to refinance to a 20-year mortgage to pay off your loan sooner and reduce your interest payments.
- No cash-out: Rate-and-Term Refinancing is not a cash-out refinance, which means you won’t be borrowing additional money beyond the amount of the outstanding mortgage balance. If you need to tap into your home equity, you may want to consider other refinancing options like a cash-out refinance.
Before you decide to refinance your mortgage, there are some important factors to consider:
- Closing costs: Just like when you took out your original mortgage, refinancing your mortgage will involve closing costs. These costs can be anywhere from 2% to 5% of your total loan amount, so make sure you factor them into your decision.
- Break-even point: To ensure that refinancing is worth it, you should calculate your break-even point. This is the point at which your new monthly payment saves you enough money to recoup the cost of refinancing. If you plan to move before reaching the break-even point, refinancing may not be worth it.
If you are considering rate-and-term refinancing, it’s important to shop around and compare offers from different lenders. Be sure to ask about their interest rates, fees, and closing costs to make an informed decision.
| Pros | Cons |
|---|---|
| Lower interest rates can save you thousands of dollars over the life of your loan | You may have to pay closing costs, which can be anywhere from 2% to 5% of the total loan amount |
| You can change your loan term to save money on interest | If you plan to move before reaching the break-even point, refinancing may not be worth it. |
| No cash-out refinance, which means you won’t be borrowing additional money beyond the amount of the outstanding mortgage balance |
Overall, rate-and-term refinancing can be a great option for homeowners looking to secure better terms on their mortgages. By taking advantage of lower interest rates and adjusting your loan term, you can save money and pay off your mortgage sooner.
Choosing the Right Refinancing Option
Refinancing is a great way to lower monthly payments and save money in the long run. However, with so many different types of refinancing options available, it can be overwhelming to decide which one is the right fit for you. Here are two common types of refinancing and how to choose the best option for you.
- Cash-Out Refinancing: This type of refinancing allows you to take out a new mortgage for more than you currently owe on your home. The difference between the new mortgage and your old mortgage is paid out to you in cash. Homeowners often choose this option to fund home improvement projects, pay off high-interest debt, or cover unexpected expenses.
- Rate-and-Term Refinancing: This type of refinancing is designed to lower your interest rate and/or shorten the term of your mortgage. Homeowners often choose this option to reduce their monthly mortgage payments, pay off their mortgage sooner, or switch from an adjustable-rate mortgage to a fixed-rate mortgage.
So, how do you choose which refinance option is right for you? Here are some factors to consider:
- Your financial goals: Do you want to lower your monthly payments or pay off your mortgage sooner? Are you looking to fund a home improvement project or pay off high-interest debt? Your financial goals will influence which refinancing option is best for you.
- Your current mortgage: How much equity do you have in your home? How long have you had your current mortgage? How much longer do you have on your current mortgage term? The answers to these questions will determine which refinancing option is available to you and if it makes financial sense.
- Your credit score: A good credit score will not only increase your chances of getting approved for a refinance, but it will also help you secure a better interest rate, which can save you money in the long run.
| Refinancing Type | Pros | Cons |
|---|---|---|
| Cash-Out Refinancing | Access to cash for home improvement or debt consolidation | Increased mortgage balance and potentially higher interest rate |
| Rate-and-Term Refinancing | Lowers monthly payments or shortens mortgage term | May not be available to all homeowners and may require higher credit score |
Ultimately, the best way to determine the right refinancing option for you is to consult with a mortgage professional. They can help you evaluate your financial goals and current mortgage to determine if refinancing is the right option for you, and which type of refinancing will provide the most benefits.
FAQs: What Are Two Types of Refinance?
Q: What is a rate-and-term refinance?
A: A rate-and-term refinance is when a borrower refinances their mortgage loan to receive a lower interest rate or to change the length of their loan term but does not take out any additional funds.
Q: What is a cash-out refinance?
A: A cash-out refinance is when a borrower refinances their mortgage loan and takes out additional funds, based on the home’s equity, to use for other expenses such as renovations or debt consolidation.
Q: What is the main benefit of a rate-and-term refinance?
A: The main benefit of a rate-and-term refinance is that it can lower a borrower’s monthly mortgage payment and potentially save them thousands of dollars over the life of the loan.
Q: What is the main benefit of a cash-out refinance?
A: The main benefit of a cash-out refinance is that it allows borrowers to access the equity in their home to use for other expenses, potentially at a lower interest rate than other types of loans.
Q: Are there any drawbacks to a cash-out refinance?
A: The main drawback to a cash-out refinance is that borrowers may end up with a higher loan balance and monthly payment, which could affect their ability to make their payments on time or pay off their loan in a timely manner.
Q: Which type of refinance is right for me?
A: The type of refinance that is right for you depends on your individual financial situation and goals. It is best to speak with a licensed mortgage professional to determine which option is best for you.
Closing Thoughts
Thanks for reading about the two types of refinance! Whether you are considering a rate-and-term refinance or a cash-out refinance, be sure to do your research and speak with a licensed mortgage professional to determine which option is best for you. We hope to see you again soon for more helpful financial tips.