Rate-and-Term vs. Cash-Out Refinance: Which One Fits Your Situation

The core difference: what you're borrowing against

A rate-and-term refinance replaces your current mortgage with a new one at a different interest rate or loan length, keeping the borrowed amount the same. A cash-out refinance lets you borrow more than you owe and take the difference in cash. The choice depends on what you need the money for and whether you can afford the larger loan.

With a rate-and-term refinance, you refinance the exact balance you still owe. If you owe $250,000 and rates have dropped, you refinance $250,000 at the lower rate. Your monthly payment goes down, or you pay off the loan faster, or both. You walk away with nothing in your pocket but a smaller bill each month.

With a cash-out refinance, you refinance for more than you owe. If you owe $250,000 and your home is worth $350,000, you might refinance for $300,000. The lender pays off your old $250,000 loan and gives you $50,000 in cash. You now owe $300,000 instead of $250,000, so your monthly payment goes up even if rates stay the same.

Key Takeaways

• Rate-and-term refinances lower your monthly payment or shorten your loan without borrowing extra money; cash-out refinances let you borrow more and take the difference as cash.
• Cash-out refinances cost more upfront because you are borrowing a larger amount, and your monthly payment will be higher even if interest rates drop.
• Lenders typically allow you to borrow up to 80 percent of your home's current value minus what you still owe, though this varies by lender and your credit profile.
• Rate-and-term refinances make sense when rates have fallen or you want to change your loan length; cash-out refinances make sense when you need money for a specific expense and have built equity.

When a rate-and-term refinance makes sense

You refinance the same amount for one of two reasons: interest rates have dropped since you took out your original loan, or you want to change how long you have to pay it back. If you locked in at 6 percent and rates are now 4.5 percent, refinancing saves you money every month for the life of the loan. If you have 25 years left on a 30-year mortgage and want to pay it off in 15, you refinance into a 15-year term.

The math is straightforward: lower rate means lower payment, shorter term means you pay less interest overall but higher payment. You need to run the numbers against your closing costs to see when you break even. If closing costs are $3,000 and your monthly savings are $150, you break even in 20 months. If you plan to stay in the house longer than that, the refinance pays for itself.

Rate-and-term refinances also work when you want to drop an adjustable-rate mortgage before the rate adjusts upward, or when you want to remove a co-borrower by refinancing into your name alone. The loan amount stays the same; only the terms change.

When a cash-out refinance makes sense

You take cash out when you need money for something specific and you have built equity in your home. Common reasons are home repairs or renovations, paying off high-interest debt like credit cards, funding education, or covering a large medical bill. The advantage is that mortgage interest rates are usually lower than credit card rates or personal loan rates, so borrowing against your home can be cheaper than other options.

The disadvantage is that you are putting your home at risk. If you cannot pay back the larger loan, the lender can foreclose. You are also extending the time you spend paying for whatever you bought with that cash. If you take out $50,000 to renovate your kitchen and refinance into a 30-year mortgage, you are paying for that kitchen for 30 years, not five.

Cash-out refinances also reset your loan term. If you have 10 years left on your current mortgage and you refinance for 30 years, you have added 20 years of payments even though you are only borrowing a little extra. Some lenders offer shorter terms, but the monthly payment will be higher.

How much you can borrow with a cash-out refinance

Most lenders allow you to borrow up to 80 percent of your home's current market value, minus what you still owe. If your home is worth $400,000 and you owe $250,000, you can borrow up to $320,000 (80 percent of $400,000). Subtract what you owe, and you can take out $70,000 in cash.

Some lenders go higher — up to 85 or 90 percent of home value — but the interest rate will be higher because the lender is taking on more risk. A few lenders go as high as 95 percent, but this is rare and expensive. The exact limit depends on your credit score, income, debt-to-income ratio, and the lender's own rules.

You will need a current home appraisal to determine what your home is worth. The appraisal costs $300 to $500 and is ordered by the lender. If the appraisal comes in lower than you expected, the amount you can borrow goes down.

Closing costs and fees for both types

Both rate-and-term and cash-out refinances charge closing costs, typically 2 to 5 percent of the loan amount. On a $250,000 rate-and-term refinance, that is $5,000 to $12,500. On a $300,000 cash-out refinance, it is $6,000 to $15,000. Costs include the appraisal, title search, underwriting, attorney fees, and lender fees.

Some lenders let you roll closing costs into the new loan instead of paying them upfront. This means you do not write a check at closing, but you pay interest on those costs for the life of the loan. A $10,000 closing cost rolled into a 30-year mortgage at 5 percent costs you roughly $5,400 in interest over time.

Rate-and-term refinances sometimes have lower closing costs because there is no appraisal or less underwriting work. Some lenders offer streamlined refinances with minimal fees if you are refinancing with the same lender. Cash-out refinances always require a full appraisal and underwriting because the lender is lending more money.

How credit and debt affect your options

Both types of refinances require a credit check and a review of your income and debts. Lenders want to see that you can afford the new payment. For a rate-and-term refinance, the bar is usually lower because your payment is going down or staying similar. For a cash-out refinance, the lender is more cautious because your payment is going up.

Your debt-to-income ratio — the percentage of your gross monthly income that goes to debt payments — matters more for cash-out refinances. If you already carry a lot of debt, taking out more cash may push you over the lender's limit. Most lenders want your debt-to-income ratio to stay below 43 percent, though some go as high as 50 percent.

If your credit score has dropped since you took out your original mortgage, you may not may have access to for the rate you expected, or you may not may have access to for a cash-out refinance at all. A rate-and-term refinance is sometimes possible even with a lower score, especially if you are refinancing with your current lender.

Tax and insurance changes after refinancing

Refinancing does not change your property taxes, but it can change your homeowners insurance requirements. If you are taking cash out and your loan-to-value ratio increases, your lender may require you to carry more insurance. If you are paying off your loan faster with a rate-and-term refinance, your escrow account — the account your lender holds for taxes and insurance — may need to be adjusted.

If you refinance for a cash-out amount and use it to improve your home, your property tax assessment may increase in some states. A new kitchen or addition can trigger a reassessment. Check your local tax assessor's rules before you refinance for a major renovation.

Frequently Asked Questions

Can I do a rate-and-term refinance if my credit score dropped?

It depends on how much it dropped and which lender you use. Refinancing with your current lender is often easier because they already know your payment history. If you are shopping around, a score drop of 20 to 30 points may not disqualify you, but you may get a higher interest rate. A larger drop can make refinancing difficult or impossible.

What happens to my original loan when I refinance?

The new lender pays off the old loan in full at closing. You sign new loan documents and a new promissory note. The old lender releases the lien on your home, and the new lender files a new one. From that point forward, you owe the new lender, not the old one.

Can I refinance if I am underwater on my mortgage?

A rate-and-term refinance is difficult if you owe more than your home is worth, though some government programs like HARP (Home Affordable Refinance Program) have allowed it in the past. A cash-out refinance is not possible because there is no equity to borrow against. Check with your current lender about options if you are underwater.

How long does a refinance take from start to closing?

Most refinances close in 30 to 45 days. The timeline depends on how quickly you provide documents, how fast the appraisal is ordered and completed, and how busy the lender is. Rate-and-term refinances sometimes close faster because there is less underwriting work.

Should I refinance if I only have a few years left on my mortgage?

A rate-and-term refinance makes sense only if the interest rate savings outweigh the closing costs and you plan to stay in the home long enough to break even. If you have three years left and closing costs are $5,000, you need to save at least $140 per month to break even. A cash-out refinance usually does not make sense because you are extending a loan that was almost paid off.