How to Pick the Right Type of Refinance

Blog posted On January 13, 2022

Refinancing your mortgage can be a great financial move for several different reasons. Depending on your financial goals, you can choose the refinance loan that suits your personal needs the best.

What are the refinance options?

           Rate-and-term refinance

A rate-and-term refinance is when you replace your existing mortgage with a new mortgage in order to switch to a lower interest rate or shorten your loan term. You can also switch from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage or cancel your mortgage insurance payments.

            Cash-out refinance

A cash-out refinance has all the same functions as a rate-and-term refinance. However, with a cash-out refinance, you can exchange some of your home’s equity for cash. As a result, you would replace your existing mortgage with a new loan at a higher amount.   Typically, you can withdraw up to 80% of your home’s equity.

For example, if your home is valued at $400,000 and your current mortgage balance is $300,000, you have $100,000 in home equity. With a cash-out refinance, you can make a new home loan higher than your previous balance of $300,000, but normally it will not be able to exceed 80% of your home’s value. Therefore, your new loan would be a maximum of $320,000, giving you $20,000 in cash.

When should you get a rate-and-term refinance?

To lower your monthly payments

If you’re looking for a quick way to cut down on your monthly spending, a rate and term refinance can be a good option. Let’s say you purchased your home with a 30-year loan of $350,000 with an interest rate of 4.3%* (4.5%APR). Your monthly payments would be $1,773. If you refinanced and lowered your interest rate to 2.8%* (3% APR), you would only pay $1,476 per month. The payment stated does not include taxes and insurance, which will result in a higher payment.

To lock in low rates and predictable payments

A rate-and-term refinance is also a good opportunity to switch to a fixed-rate loan. With an adjustable-rate loan, your mortgage rate varies depending on the current market rate. When the market rate goes up, your mortgage rate will go up – leading to higher monthly payments. With a fixed-rate loan, you can lock in your mortgage rate while market rates are still low and make the same monthly payments throughout the life of your loan.

To stop paying costly mortgage insurance

Mortgage insurance can cost .5% to 1% of your loan amount every year. For a $350,000 loan, this would mean up to $3,500 every year. With a rate-and-term refinance, you can cancel your mortgage insurance payments as long as you have at least 20% equity in your home. If you have an FHA loan, you might need to refinance to a different loan in order to start paying mortgage insurance.

Why should you get a cash-out refinance?

            To consolidate high-interest debt

If you have a lot of high interest debt, like credit card debt, a cash out refinance can be a good way to pay off those balances quicker. Interest rates for a mortgage loan tend to be much lower than interest rates for a credit card.

            To fund home renovations

By using your home’s equity to repair or improve your home, you could improve the home’s value, which would help you gain equity in the long run and sell it at a higher price in the future. Renovating your home could also earn you a tax deduction.

            To finance a second home

If you’ve been wanting to invest in more real estate, cash out refinance is a great tool to help you fund the down payment on a new home.

Refinancing your mortgage interest rates are low can help you save money in several different ways. If you would like to see how the refinance can help you, try out our mortgage calculator page.

Sources: Bankrate