Understanding the Different Mortgage Refinance Options
If you think that your current mortgage terms could be better, than refinancing your mortgage might be the right financial decision for you.
A mortgage refinance has its benefits, including possibly securing a lower interest rate thus reducing your monthly home loan payments or extending the years on your mortgage repayment term.
However, a mortgage refinance is certainly not the right financial action for everyone, and sometimes refinancing your home loan can actually lose you money. For example, a low credit score at the time of refinancing may lead to you getting an even higher interest than on your previous mortgage.
True Quote Mortgage’s mortgage refinance calculator can help you get a more accurate idea as to if mortgage refinancing is the right personal finance decision based on your unique set of circumstances.
And if a mortgage refinance looks and feels right to you, the homeowner, you will want to explore a few different refinancing options that are available.
When discussing a mortgage refinance, there are really three main options that you can choose from, including a cash-out refinance, a rate-and-term refinance, and a cash-in refinance.
In this article, we will explain each of the three aforementioned mortgage refinance options, in addition to the pros and cons of each.
A cash-out refinance will swap your current mortgage with a new mortgage that will be of greater value than what you had still owed on your previous mortgage. That difference between the size of your new mortgage and your old mortgage balance will be given to you in the form of cash.
Because you are receiving cash through a cash-out refinance, this type of mortgage refinance is great for when you want to make home improvements or larger renovations, consolidate debt, or simply have cash on hand for other expenses.
To utilize a cash-out refinance, you must build up enough equity in your home. Further, you can only cash-out up to 80% or 90% of your home equity, not 100%.
So, if your home is valued at $400,000 and your remaining mortgage balance is $200,000, you have $200,000 of equity in your home. With a cash-out refinance, you could refinance that $200,000 mortgage balance for $300,000, and get $100,000 in cash.
Pros of a Cash-Out Refinance
- Lower interest rate: If current mortgage rates are lower than when you took out your first mortgage, you could possibly secure a lower interest rate.
- Paying off debt: If you have high-interest debt, which is typically seen with credit cards, you could use the money from a cash-out refinance to pay off debts and improve your credit score.
- Free up cash to make home improvements: The cash from a cash-out refinance can be used to make improvements to your home, which will increase the home’s value.
Cons of a Cash-Out Refinance
- Risk of foreclosure: If you are unable to make monthly mortgage payments, which are usually larger after using a cash-out refinance, you run the risk of losing your home to foreclosure.
- Closing costs: After doing a cash-out refinance, you will need to pay for closing costs again, which are usually between 2% and 5% of the mortgage.
- Using a cash-out refinance for the wrong reasons: You should only use the cash from a cash-out refinance for things that will increase in value over time, like home improvements and not a new television as you still need to repay the cash that was taken out and repayment is easier when you used the cash-out refinance to increase your net worth.
A rate-and-term mortgage refinance is the most common type of mortgage refinancing and simply replaces your old mortgage with a new one that features the same mortgage balance.
You can utilize a rate-and-term refinance to hopefully improve your interest rate or extend your repayment term, but the mortgage balance will remain the same.
With a rate-and-term refinance, your new mortgage lender will pay off your existing mortgage, and you will owe your monthly payments to the new lender.
Pros of a Rate-and-Term Refinance
- Lower interest rate: Ideally, your new mortgage will have a lower interest rate due to things like a looser lending environment or an increased credit score.
- Extended repayment term: This type of mortgage refinance may also extend the number of years you have to repay your home loan.
- Switch from adjustable-rate mortgage (ARM) to fixed-rate mortgage: Switching from an ARM, which is harder to budget for due to unpredictable interest rate changes, to a fixed-rate mortgage will make your monthly payments consistent and easy to plan for.
- Eliminate Private Mortgage Insurance (PMI): It is possible to drop the added costs that came with PMI on your old mortgage after refinancing.
Cons of a Rate-and-Term Refinance
- Closing costs: Just as with any type of mortgage refinancing, you will have to pay for closing costs again.
- Higher interest rate or worse repayment terms: If your credit score has worsened since your first mortgage, you will likely receive worse repayment terms, including a higher interest rate.
- Additional credit inquiries: A mortgage refinance lender will do a hard credit pull during the application process, which will ding your credit score negatively.
Not surprisingly judging by its name, a cash-out refinance is the opposite of a cash-out refinance in that you are bringing money to the refinance closing table to lower your mortgage balance, as opposed to taking on a larger mortgage balance to access cash.
Let’s say that you have found yourself in a more favorable financial situation from when you took out your original mortgage and have more cash in the bank. With a cash-in refinance, you can use that money to put more money down during the refinance closing process and lower your mortgage balance. Additionally, the extra money down will likely lower your interest rate or shorten your repayment term.
Cash-in refinances are often used to lower your loan-to-value ratio (LTV) if it is approaching the maximum level. For example, if your home’s value is $100,000 and your mortgage balance is $110,000, you can use a cash-in refinance to lower your mortgage balance to $95,000, thus getting your LTV to 95%.
Pros of a Cash-In Refinance
- Lower your loan amount: A cash-in refinance can get your mortgage balance to a level that is at or below the maximum LTV allowed by the mortgage lender.
- Rid yourself of PMI: By increasing your equity in the home, it is possible that the new mortgage lender will no longer require PMI.
- Lower your interest rate: The new mortgage lender could provide a lower interest rate since you have mitigated their risk by increasing your equity in the home.
Cons of a Cash-In Refinance
- Closing costs: Once again, refinancing your mortgage with a cash-in refinance will lead to you have to pay closing costs again.
- Better uses for your cash: Consider other ways that you might be able to better use that cash, like an investment account or college savings fund.
- Cash is locked: Let’s say you end up having an emergency expense right after using a cash-in refinance. Instead of having access to that cash for the expense, it will be locked in with the new mortgage lender and you may have to take on a whole lot of debt.
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