Rate-and-term vs cash-out refinance: which is right for you
Refinances come in two main shapes, and they answer two different questions. One is about getting a better deal on the debt you already have. The other is about converting some of your home’s value into cash. Mixing them up leads to the wrong decision, so it is worth being clear about which one you actually want.
Rate-and-term refinance
A rate-and-term refinance keeps your balance roughly the same and changes the terms of the loan: a lower interest rate, a different payoff length, or both. You are not borrowing extra; you are replacing your current loan with a better-priced one for about the same amount. This is the refinance most people mean when they talk about "refinancing for a lower rate," and it is the kind Wend’s breakeven verdict evaluates.
Cash-out refinance
A cash-out refinance replaces your mortgage with a larger one and gives you the difference in cash, drawn from your home equity. If you owe $200,000 and refinance into a $250,000 loan, you walk away with roughly $50,000 in cash and a bigger balance to pay back. It can be a reasonable way to fund a large expense, often at a lower rate than other borrowing, but it raises your balance and usually carries a slightly higher rate than a rate-and-term refinance.
How to choose
If your goal is to lower your rate or change your term, you want a rate-and-term refinance, and breakeven is the test. If you specifically need cash and have equity to draw on, a cash-out refinance is one option to weigh against alternatives like a home equity line. Just keep the two motives separate: deciding to tap equity because rates happen to be low, or accepting a worse rate-and-term deal because you also want some cash, is how people end up with a refinance that does not really serve either goal well.
- Consumer Financial Protection Bureau, "When can refinancing make sense?"
- Freddie Mac, Cash-out Refinance Basics