Sorry but we mortgage companies do have our fair share of loan terms and when someone is refinancing a mortgage yes there are different types. The most common are the cash-out refinance and rate and term. What are the differences between the two terms and why should it matter? Let’s take a closer look at refinancing and what makes one and what makes the other.
A rate and term refinance is a transaction where a new mortgage replaces an old one. A refinance can replace a new interest rate on a loan. This is the “rate” part of the rate and term refinance. It’s easy enough to understand as it becomes apparent that refinancing to a lower rate will benefit the borrower with lower overall monthly payments.
You can also adjust the term during a refinance. Terms for conventional mortgages can be as short as 10 years and as long as 30. Most lenders offer loan terms of 10, 15, 20, 25 and 30 years. Why the different terms? A longer term keeps the payment lower than a shorter one yet at the same time it takes longer to pay down the mortgage and there is much more interest paid over the life of the loan with a 30 year loan compared to a 20 year, for example.
Or, a borrower has a 30 year loan but is five years into it. If the borrower sees a lower rate and refinancing makes sense it might not make sense to take out another 30 year loan, losing five years of payments. In this example it might be better to refinance from a 30 year loan into a 25 or 20 year term.
Finally, a borrower can refinance both the rate as well as the term. Getting a lower rate while shortening or lengthening the term of the loan. This is a rate and term option.
A cash out loan is one that refinances the rate, the term or both while at the same time pulling out equity in the form of cash at the closing table. Most conventional loans allow borrowers to pull up to 80% of the equity in their home when refinancing and pulling out cash although there are slightly better terms if the borrowers pull out cash if the loan is at 75% or even 70% of the current appraised value of the home. There are times when a cash out refinance will have a higher rate, albeit slightly, compared to a rate and term refinance.
A cash out refinance should only be considered if a rate and term makes sense, anyway. Why? Because there are closing costs with any mortgage and those costs must be considered when deciding whether or not to refinance. If a rate and term makes sense then why not consider pulling out some very cost effective cash with very low rates compared to other lending options. If all the home owner needs is cash, a less expensive option is a home equity loan or home equity line of credit.
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