Rate refinancing, also known as rate-and-term refinancing, differs significantly from cash-out refinancing in terms of purpose, financial implications, and process.
Rate Refinancing
This option involves replacing an existing mortgage with a new one that has better terms, primarily a lower interest rate, or a different loan term. The main goal is to reduce the monthly payments or the overall interest paid over the life of the loan. Homeowners typically opt for rate refinancing to take advantage of improved interest rates or to switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage for more predictable payments. Generally, no additional cash is taken out during this process.
To be eligible for rate refinancing, lenders typically require a good credit score, sufficient home equity, and a stable income. Closing costs, which usually range from 2% to 5% of the loan amount, still apply.
Cash-Out Refinancing
Cash-out refinancing, on the other hand, involves taking out a new mortgage for more than the amount owed on the existing loan and receiving the difference in cash. This type of refinancing allows homeowners to tap into their home equity to fund major expenses like home renovations, debt consolidation, or other financial needs.
Eligibility for cash-out refinancing similarly involves a good credit score, a certain percentage of equity in the home (typically at least 20%), and proof of income. Higher closing costs are common, and the overall loan amount will increase, leading to potentially higher monthly payments. Additionally, because the loan-to-value ratio increases with a cash-out refinance, the interest rate might be slightly higher compared to rate refinancing.
Choosing between the two depends on personal financial goals, equity status, and the necessity for cash. Homeowners need to assess their long-term financial plan to determine which refinancing option best meets their needs.