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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 (PMI). Each borrower’s goals and financial picture is unique, which means there isn’t one type of refinancing that makes sense for everyone.
Refinancing — and choosing which sort of refinance method fits your needs — is a major decision. We will guide you through the many refinance options that are available to help you determine which is best for you.
Things to consider before choosing a refinance option
Before you choose the best scenario for refinancing for you, consider the following factors:
- Your existing mortgage payment, rate and term
- Your financial situation, including your credit score, LTV ratio and DTI ratio
- Your savings/investment goals and how they apply to your reasons for refinancing
- How much equity you have in your home
- How long you plan to stay in the home
- Closing costs (paying them upfront vs. over time)
Each of these factors will inform what refinance option is right for you (if any).
Mortgage refinance options
There are several types of mortgage refinance options to achieve different financial goals. They include:
- Rate-and-term refinance: Refinancing to change the interest rate and/or length of the loan
- Cash-out refinance: Refinancing to take equity out of your home in the form of cash
- Cash-in refinance: When a borrower makes a lump sum payment during their refinance
- Streamline refinance: Available for FHA, USDA and VA loans — can be quicker and require less paperwork than traditional refinances
- No-closing-cost refinance: Does not require you to pay at closing — closing cost is rolled into your principal or you get a higher interest rate
- Short refinance: Can occur when a borrower is underwater on their mortgage and having trouble paying it — lender may agree to refinance the loan to match the current market value
- Reverse mortgage: Lets senior homeowners turn their equity into a regular, fixed-income stream
Rate-and-term refinancing is one of the best-known types of refinancing. It allows you to 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.
Before you apply for a refinance, check your credit score and loan-to-value ratio (LTV). 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 you’ll need to pay for private mortgage insurance (PMI).
Changing the mortgage rate
If you’re in good financial standing, a rate-and-term refinance can make sense when refinance rates are lower than your current mortgage rate. Unfortunately, since rates are currently quite high, now likely isn’t the right time to refinance to a lower rate.
However, let’s say you currently have a rate of 6.25 percent and rates have dropped to 5 percent. By refinancing, you could save significantly on your monthly payment, as well as on the total interest you’ll pay throughout the loan’s term. Plug the numbers into our refinance calculator and see what impact a drop in rates could have on your payments.
Changing the mortgage 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, since this doesn’t change the amount you owe, it 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 on interest, you would need to lower your interest rate and shorten your loan’s term.
Here are three scenarios that show the differences between a 30-year, 15-year and 10-year term on a $300,000 loan with a fixed rate of 5.5 percent. Note: These payments don’t account for property taxes, insurance or other fees.
|30-year fixed mortgage||15-year fixed mortgage||10-year fixed mortgage|
|Total interest paid||$313,415||$141,250||$90,726|
|Total cost of the loan||$613,415||$441,250||$390,726|
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.
Of course, while these scenarios provide a helpful example of refinancing options, that doesn’t necessarily mean that you should refinance right now. Rate-and-term refinancing makes the most sense when you can lock in a lower rate than your current one, but since interest rates are so high at the moment, waiting to refinance is probably your best bet.
A cash-out refinance allows borrowers to turn their home equity — the amount of the house they own outright — into cash. Borrowers refinance their mortgage (the same way you would with a rate-and-term refinance) and get the funds transferred to their account usually within a week after they close. 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 (in this case, $60,000) 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 even 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 home equity might stand a better chance of qualifying for this type of 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 financial opportunities, a cash-in refinance might not be the best use of your funds.
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. The major programs include:
- FHA streamline refinance: This program lets you refinance your FHA-backed loan as long as it’s in good standing and provides you with a “tangible benefit,” such as a lower rate.
- VA streamline refinance: Called an interest rate reduction refinance loan (IRRRL), a VA streamline refinance can help you secure lower monthly payments and a reduced interest rate.
- USDA streamline refinance: You can refinance your USDA or USDA-backed loan with this program as long as it helps you achieve at least a $50 net reduction in your monthly mortgage payment.
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. Bankrate’s refinance break-even calculator can help you run the math on different scenarios.
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.
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. It works the opposite of a regular mortgage: The reverse mortgage lender makes payments to the homeowner (hence the name). This income is tax-free, but accrues interest.
These types of refinance loans 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 many 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.
FAQ about mortgage refinancing
While refinancing your mortgage can offer a few benefits, you’ll also need to be prepared to pay closing costs (similar to your first mortgage). Typically, these run between 2 percent and 5 percent of your loan’s principal.
Generally, finalizing one of these home refinance options takes between 15 and 40 days — about as long as obtaining a regular mortgage.
Whether you’re applying for a mortgage or refinance, it pays to shop around and compare rates from several lenders. Bankrate can help. Visit our refinance hub for the latest rates from popular lenders, as well as resources on how to choose the best scenario for refinancing and answers to the most common questions about mortgage refinances.
The right time to refinance depends on your current mortgage, your finances and your goals. In general, you’ll need to have at least 20 percent equity in your home to refinance. You also may want your new mortgage rate to be lower than your current mortgage rate.
Refinancing will minimally hurt your credit score in the short-term as your lender will have to perform a hard credit pull. However, continuing to pay your mortgage (and other loan payments) on time can help you improve your score.
A traditional rate-and-term refinance will not affect your property taxes. However, if you use the money from a cash-out refinance for home improvements, that can cause your property value to rise and trigger a property tax assessment.