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How to choose the right kind of refinance for you

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There are many reasons refinancing can be a smart financial move, such as lowering your mortgage payments and eliminating private mortgage insurance. Each borrower’s goals and financial picture is unique, which means there isn’t one type of refinancing that makes sense for everyone.

Rate-and-term refinance

Rate-and-term refinancing is when you replace your existing mortgage with a new mortgage that has a different interest rate, a different loan term (the length of your mortgage) or both.

Rate-and-term refinance to a lower rate

For borrowers with strong credit scores (a minimum of 700, but the higher the better) and low loan-to-value ratios (LTV), this is an excellent time to shop around for low interest rates. More lenders are advertising rates in the low 3s and even 2s, but they’re also raising minimum requirements. You can compare refinance offers on Bankrate.

Before you apply for a refinance, check your credit score and LTV (use Bankrate’s LTV calculator). An ideal scenario for conventional refinancing is a FICO score above 700 and an LTV below 60 percent. Borrowers can qualify for refinancing with LTVs of 80 percent or lower. Anything more than 80 percent and private mortgage insurance kicks in.

Rate-and-term refinance to a different loan term

You also can change the term of your mortgage. If you want to pay off your mortgage faster (and reduce the total amount of interest you pay), you can refinance into a shorter loan. Of course, this doesn’t change the amount you owe, which means your monthly payments will be higher.

Let’s say you only have 10 years left on your existing 30-year mortgage. You can refinance into another 30-year fixed-rate mortgage with a lower interest rate. This will reduce your monthly payments, but you will pay more in total interest because you’re resetting your loan. To maximize your total savings, you should lower your interest rate and shorten the term of your mortgage.

Here are three scenarios that show what happens when you reduce the rate on a $200,000 loan to 3.5 percent with a 30-year, 15-year and 10-year fixed-rate mortgage.

30-year fixed mortgage 15-year fixed mortgage 10-year fixed mortgage
Monthly payment $898.09 $1,429.77 $1,977.72
Total interest paid $123,312.18 $57,357.710 $37,326.08
Total cost of the loan $323,312.18 $257,357.71 $237,326.08

If your goal is to reduce interest on the life of the loan, then the 10-year fixed-rate option is the best one. Keep in mind that you might get a better interest rate on a shorter loan, which would help ease those monthly payments and further trim your total interest debt.

Cash-out refinance

A cash-out refinance allows borrowers to tap equity in their home while also lowering their mortgage interest rate. Borrowers refinance their mortgage (the same way you would with a rate-and-term refinance) and get a check for the amount they borrow at closing. The new balance is higher because it reflects the borrowed amount, plus any closing costs you roll into the loan.

Typically, lenders cap the amount you can borrow at 80 percent of the equity you have in your home, which would leave 20 percent tied up in the house.

For example, if your home is currently appraised at $300,000 and you owe $100,000, you can get up to $140,000 in cash out, which would leave the minimum 20 percent equity left in your home.

A cash-out refinance may make sense for borrowers who want to make home improvements or need emergency funds with a relatively low interest rate. After all, mortgage money is the most favorable debt available to most consumers.

However, experts advise against tapping your equity for lifestyle purchases, such as vacations or entertainment, and to think twice before tapping home equity to pay down credit card balances. If you don’t address the issues that led you to run up the credit card debt in the first place, you’re likely to repeat the pattern of overspending.

Borrowers with higher credit scores and more equity might stand a better chance of qualifying for this type of refinance.

Cash-in refinance

With a cash-in refinance, you make a lump-sum payment instead of taking cash out of your equity. A cash-in refinance can be an option if your LTV ratio isn’t where lenders typically require it for a refinance, or if you simply want to refinance to a smaller loan.

Aside from cutting down your debt load, cash-in refinances have some advantages. Bringing money to the table will lower your LTV ratio, helping you qualify for a lower interest rate and lower monthly payments. With a reduced LTV ratio, you might also be able to eliminate PMI.

Of course, all of this is in exchange for a sizable lump sum upfront. If paying that lump sum would empty your savings or mean turning down other potentially more lucrative opportunities, a cash-in refinance might not be the best use of your funds.

Streamline refinance

Streamline refinances are an efficient way to get a lower rate on an FHA, VA or USDA mortgage because they involve relatively little paperwork and don’t require a credit check or appraisal. The result is potentially faster turnaround times and lower closing costs.

For an FHA streamline refinance, you must already have an FHA loan in good standing, and the refinance must result in a “tangible benefit” to the borrower, such as a lower rate. The VA streamline refinance, called an Interest Rate Reduction Refinance Loan (IRRRL), and the USDA streamline programs have similar respective requirements.

No-closing-cost refinance

In a no-closing-cost refinance, you don’t pay closing costs for the refinance upfront. Instead, you finance these fees with the loan (and pay interest on the larger loan amount), or pay a higher interest rate.

A no-closing-cost refinance can be tempting since it eliminates the need for you to have cash ready at closing, but depending on how long you plan to stay in the home, that convenience can cost you significantly more in the long run. Use Bankrate’s refinance break-even calculator to weigh different scenarios.

Short refinance

In a short refinance, a mortgage lender offers a distressed borrower a new loan in an amount that’s lower than the original balance, and might choose to forgive the difference. For the lender, accepting lower payments might be more cost-effective than foreclosure proceedings. For the borrower, a short refinance helps avoid foreclosure, but can harm their credit.

Reverse mortgage

With a reverse mortgage, homeowners aged 62 or older who have substantial equity in their home or paid off their mortgage in full can withdraw equity as income and don’t need to repay it until they leave the home. Unlike a regular mortgage, the lender makes payments to the homeowner. This income is tax-free, but accrues interest.

Reverse mortgages offer a steady stream of cash for a variety of purposes, such as supplementing retirement income, paying for home repairs or covering medical expenses. The amount varies depending on a number of factors, including the age of the youngest borrower or eligible non-borrowing spouse, the home’s value, the HECM borrowing limit and current interest rates.

How to choose the best type of refinance

Consider your existing mortgage payment, rate and term, along with your goals and timeline, to determine which type of mortgage refinance is right for you. You’ll also need to think about closing costs and whether you’re prepared to pay them upfront or over time in a no-closing-cost loan.

If you qualify for a lower interest rate, plan to stay in your home for a long time and can afford the closing costs, for example, you might come out ahead with a rate-and-term refinance. Alternatively, a cash-out refinance might fit your needs better if you’re looking for a way to pay for a large expense, such as home improvements, at a relatively low rate.

Written by
Ruben Caginalp
Associate writer
Ruben Çağınalp is an associate writer for Bankrate, focusing on mortgage topics.
Edited by
Mortgage editor
Reviewed by
Senior wealth manager, LourdMurray