Mortgage interest rates have dropped significantly during the COVID-19 pandemic, with rates for 30-year, fixed-rate mortgages currently available at 3.3%. These record-low rates have spurred interest in some homeowners to refinance their mortgage and get cash out.
Are you considering a refinance of your mortgage to a new, low rate? It is essential to understand the differences between the types of refinances that are available. Some mortgage refinances involve getting cash (equity) in your pocket, while others do not.
Rate-and-Term Mortgage Refinances
A rate-and-term refinance changes the interest rate, term, or both of a current mortgage without giving cash to the homeowner. It also is called a no cash-out refinance. This is different from a cash-out refinance that provides equity to the borrower at closing in the form of cash. Rate-and-term refinances usually have a lower interest rate than cash-out refinances.
Rate-and-term refinancing is often driven by a reduction in market interest rates. Cash-out refinances tend to be driven by rising home values.
Benefits of Rate-and-Term Mortgage Refinances
You may be able to get a lower interest rate than you are paying today. For example, if you have a $200,000, 30-year mortgage at 4.5% and refinance to 3.5%, you could save approximately $115 in your monthly payment.
Refinancing to a lower rate can be a good move because it reduces the amount of interest you pay over the life of the loan.
You also can refinance the mortgage to a different term. Some people refinance their mortgage from a 30-year to a 15-year. This means the loan is paid off much faster and the borrower saves tens of thousands of dollars in interest. Fifteen-year mortgages carry lower interest rates too because shorter terms are less risky for lenders.
Another benefit of a rate-and-term refinance is that you can usually qualify for the loan easier than when pulling out cash. A cash-out refinance increases the mortgage balance and is a higher risk for the lender.
Finally, a rate-and-term refinance does not increase your mortgage balance. Taking on a higher mortgage payment is riskier for the borrower because you can lose your home if you cannot handle the higher payment.
Requirements for Rate-and-Term Mortgage Refinances
For a rate-and-term refinance to be worth it, there must be lower interest rates in the current market. Mortgage interest rates can go up and down at any time. Many experts say that you should be able to reduce your mortgage interest rate by at least .5% for the refi to be worth the cost.
It also helps to have decent credit to be able to access the lowest interest rates. Some mortgage companies have tightened their lending criteria during the current economic downturn.
For example, JPMorgan Chase is raising borrowing standards for all mortgages, with a 700 credit score required for new mortgages. These changes will affect the requirements for refinances, too.
Cash-Out Mortgage Refinances
A cash-out refinance replaces your current mortgage with a new one with a higher mortgage balance. The purpose is to convert some of your home equity into cash for home renovations, paying off credit cards, funding a college education, etc. Most cash-out refinances also have a lower interest rate than the current mortgage.
The borrower receives the difference between the two loans in tax-free cash, so it is not considered income. This is possible because you only owe your lender what is left on your original mortgage. The additional loan amount of the refinanced mortgage is usually paid at closing, which is 45-60 days after you apply.
Benefits of a Cash-Out Refinance
Cash-out refinances offer advantages over other types of financing, such as home equity lines of credit (HELOC) and home equity loans. Borrowers can often get a lower interest rate on a cash-out refinance than a home equity loan or HELOC. That is because the cash-out refinance is a first mortgage and not a second mortgage; lenders assume less risk with a first mortgage.
Cash-out refinances also are easier to qualify for than a second mortgage. Cash-out refinances are similar to an original purchase loan and are the primary type of mortgage offered by lenders. More lenders are likely to offer cash-out refinances than HELOCs or home equity loans.
If you are using your equity to improve your home, you may increase its value, which will be a benefit when you sell your home someday.
Requirements for Cash-Out Mortgage Refinances
As with any refinance, you need to have decent credit. But taking out cash requires even better credit than a rate-and-term refinance. You also should only refinance with cash out if you can lower your interest rate, so interest rates need to be lower than your current rate.
Considerations for a Cash-Out Refinance
The primary consideration for a cash-out refinance is that you increasing your mortgage balance. You will be paying a higher payment each month unless you can drop your rate so much that your payment does not change. If you cannot make your mortgage payment, the lender can take your home.
It also is more difficult to qualify for a cash-out refinance during the COVID-19 pandemic, and this could be the case for the foreseeable future. Some lenders, such as Wells Fargo, are not even allowing cash-out refinances at this time, so qualifying could be an issue.
Final Thoughts on Getting Money From Refinancing Your Home
Refinancing your mortgage for cash out can be a great idea if you have a good reason for tapping your equity. Paying for home renovations or a college education can be smart moves with your hard-earned equity.
A rate-and-term refinance can be the way to go if you want to lower your payment and/or reduce your loan term. Talk to your mortgage lender today to determine which is the better option for your situation.
- Why It’s Suddenly More Difficult to Get a Mortgage. Accessed at https://www.nbcnews.com/business/consumer/why-it-s-suddenly-more-difficult-get-mortgage-n1183266
- Rate-and-Term Refinance Overview. Accessed at https://www.investopedia.com/terms/r/rate_and_term_refi.asp
- Cash-Out Refinance Overview. Accessed at https://www.investopedia.com/terms/c/cashout_refinance.asp
- When Does a Cash-Out Refinance Make Sense For Your Finances? Accessed at https://www.forbes.com/sites/advisor/2020/04/13/when-does-a-cash-out-refinance-make-sense-for-your-finances/#7e3417692135