A Quick Guide to the Types of Home Refinance Loans
Homeowners can take advantage of three basic types of home refinance loans: cash-in, cash-out, and rate-and-term. Each type of loan has its own pros, cons, and unique features that can be beneficial to potential refinancers.
If you’ve looked into refinancing your home, then you’ll know that there are quite a few home refinance loan options available to homeowners. We’ve prepared a quick guide to help you differentiate between rate-and-term, cash-in, and cash-out refinance loans.
Types of Home Refinance Loans
The three types of refinancing loans available to homeowners in the US are rate-and-term, cash-in, and cash-out refinance loans.
Cash-out refinancing includes borrowing more money than what is owed on your current mortgage, leveraging the home’s equity. The difference between what is borrowed and what is owed is paid to the homeowner in cash and can be used for any purpose the homeowner sees fit. Cash-out refinancing is an option to consider if the equity on your home is high and you are in need of extra cash. However, not everyone is eligible for cash-out refinancing; banks normally require that there is a generous amount of equity on your
home, for example. 20%, for them to consider cash-out refinancing.
Home equity is calculated by subtracting the amount of total mortgage owed on a home from the home’s total value. For example, if your house is valued at $300,000 and your total mortgage debt is $200,000, your home has $100,000 in equity. Here is an example of a cash-out refinance: Johnny owes $100,000 on his home, which is worth $400,000. Johnny takes out a cash-out refinance loan of $150,000. Since he only owes $100,000 worth of mortgage, once that is paid off, he has the remaining $50,000 to spend on sprucing up his kitchen and bathroom and taking a vacation to the Caribbean.
Cash-in refinance is almost the opposite of cash-out – instead of getting extra money out of the refinance deal, you give money to your lender. It might sound strange, but it’s an attractive option for homeowners who either have extra disposable funds and want a shorter loan period, or do not have enough equity or owe too much to access other types of home refinance options. If you pay out a lump sum on your cash-in refinance loan, you might get your loan payment period reduced by a few years and be able to pay off your loan in a quicker time span. This would therefore leave less time for interest to accumulate, and you would end up paying less overall on your loan.
So far, we’ve covered two types of home refinance loans: cash-in and cash-out. The final type of loan we’ll cover is rate-and-term refinance. This includes taking out a new mortgage on your home that allows you to change the rate (interest rate) or term (length of time) of your loan payment. There is no money advancement involved in rate-and-term refinancing. Homeowners usually opt for rate-and-term refinance because it allows them to take advantage of lower interest rates.
This allows homeowners to shorten or lengthen the loan payment period, depending on their preferences. For example, if you originally took out a mortgage at a rate of 5% but you find that the market has shifted towards lower rates, you can opt for a refinance option that gives you an interest rate of 4.5% or 4%. This would lower your overall payment amount. This way, you could take advantage of either a shorter payment period by paying the same amount each month, but for less time, or you could keep your loan term at its original length and instead decrease your monthly payments to free up more money for other expenses.