Cash-out refinance vs. no-cash-out refinance
For many borrowers, there’s not much competition between a cash-out or no-cash-out refinance.
If you want to withdraw cash from your home equity, you’ll use a cash-out refinance (provided you’re eligible). This gives you a lump sum of cash at closing that can be used for any purpose.
But if you just want to refinance for a lower interest rate, you’ll use a no-cash-out or ‘rate-and-term’ refinance. This can lower your monthly mortgage payments and save you a lot of money in the long run.
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A no-cash-out refinance typically changes your mortgage interest rate, loan term, or both. The goal is usually to save money on your home loan, and you cannot receive cash back.
A cash-out refinance provides a lump sum of cash at closing. The cash comes from your home equity. Interest rates are typically higher for a cash-out refinance than a no-cash-out loan, and it’s a little harder to qualify.
The right type of refinance loan will depend on your financial goals. And if you’re not sure which program to choose, your loan officer can help you compare options and find the right fit.
No-cash-out refinance explained
A no-cash-out refinance is also called a rate-and-term refinance.
In other words, your goal is to get a lower mortgage rate, change the “term” (duration) of your loan, or both. Each of those will reduce your monthly payments, providing you don’t refinance to a much shorter term.
Any refinance means replacing your existing mortgage with a new one. With a rate-and-term refi, your new loan amount will be the same as your existing mortgage balance.
You may have to pay refinance closing costs out of pocket. And those can be roughly 2-5% of your loan amount.
However, you may be offered a no-closing-cost refinance. This can help you lower your rate and monthly mortgage payment without paying any upfront fees.
Just realize that no-closing-cost loans typically come with a higher mortgage rate. So you’ll pay those costs in the end. Of course, there’s nothing wrong with that, as long as you recognize what’s happening and are cool with it.
Many types of mortgages allow Streamline refinancing. A Streamline Refinance typically reduces the time, closing costs, and paperwork involved with a rate-and-term refinance. However, you can never take cash-out with a Streamline Refi.
Streamline Refinance options are available for FHA loans, VA loans, and USDA loans.
For those with conventional mortgages backed by Fannie Mae or Freddie Mac, there are new loan programs that can reduce the cost of refinancing and guarantee a lower rate. However, you’ll need a low or moderate income to qualify.
Cash-out refinancing explained
A cash-out refinance also replaces your existing mortgage loan with a new one. But, unlike a no-cash-out refi, your new loan balance will be bigger than what you currently owe. That ‘extra’ loan amount is returned to you as cash-back at closing.
What you’re doing is using home equity as collateral to secure your cash-out loan. And that allows you to borrow money at a low interest rate. This can be a much more affordable way to get a large sum of cash than using, say, credit cards or personal loans.
Benefits of cash-out refinancing
A cash-out refinance can be a low-cost way to borrow a large amount of money. Many homeowners use a cash-out refinance to fund large expenses that will ultimately increase their net worth.
For example, some of the best uses for a cash-out refinance include:
- Paying for home improvements or renovations
- Paying for higher education or a new startup business
- Consolidating high-interest debt
- Covering large, unexpected medical bills
- Buying a second home or investment property
Meanwhile, think carefully before using a cash-out refinance to fund a big event: a wedding, perhaps, or an anniversary party or once-in-a-lifetime vacation. Assuming you opt for a new 30-year mortgage, you’ll be paying for that treat — plus interest — for the next three decades.
Drawbacks of cash-out refinancing
When it comes to a cash-out refinance vs. no-cash-out refinance, cashing out has some drawbacks.
To start with, you’ll likely have to pay a higher mortgage rate than if you didn’t want cash. And the difference is often 0.125-0.25% higher.
In other words, if you could get a mortgage rate of 3.3% for a rate-and-term refinance, you’d likely pay between 3.425% and 3.55% to get cash out.
Your exact rate will depend on the lender you choose, your financial circumstances, and the amount of cash you’re taking from your home equity. You can use our mortgage refinance calculator to work out what that means for you in dollars and cents.
And, of course, you must remember that you’ll be paying that higher rate on a higher balance. Because, if you weren’t taking cash out, you’d be borrowing less.
Finally, you should be aware that most lenders have higher eligibility criteria for cash-out refinances than rate-and-term ones.
You’re more likely to be approved if you have a higher credit score and lower monthly payments on other existing debts than you’d need for a rate-and-term refinance.
How much equity can I cash out when I refinance?
Unless you have a VA loan, which is an exception, you can only cash-out some of the equity you’ve built up in your home.
Indeed, most lenders want you to retain at least 20% of your home’s value when you do a cash-out refinance. That means your maximum loan-to-value ratio (LTV) is 80 percent.
Let’s take an example:
- Home value: $350,000
- Current loan balance: $200,000
- Max. new loan amount: $280,000 (80% LTV)
- Max. cash-back = New loan amt. – Current balance
- Max. cash-back: $80,000
Not every lender or type of mortgage is that strict. But most are. And you’ll likely have to hunt for one that will let you retain less than 20% in equity.
Should you cash-out refinance or not?
As a general rule of thumb, it makes sense to do a cash-out refinance if you’ll use the cash for a smart, long-term investment with a good financial return. And you should only use one if you need a large sum of cash because the closing costs involved will likely outweigh any small sum needed.
In addition, cash-out refinancing is only a good idea when taking out a new loan won’t harm you financially. If refinancing would cost you a lot more in the long run by extending your loan term or raising your interest rate, a cash-out refi might not be the best idea.
If a cash-out refinance isn’t the right fit, don’t worry. There are likely other ways to get the funds you need. For example:
- Home equity loan (HEL) — You keep your existing mortgage and take out a second mortgage with a shorter term, often 5-15 years. You pay both mortgages in parallel. And you typically repay the HEL in equal, fixed installments
- Home equity line of credit — A bit like a hybrid home equity loan and credit card. You can borrow up to your limit, repay, and re-borrow as often as you want. And you pay interest (typically variable) only on your current balance. Usually has lower upfront costs than HELs and refinances
- Personal loan — Not a second mortgage and therefore unsecured. So expect to pay an appreciably higher rate unless your credit score is stellar and your finances exceptionally stable. Low or zero setup fees
Whether one of those will suit you better than a cash-out refinance will depend on your personal goals, needs, and circumstances. But you should definitely check them out.
Cash-out refinance vs. no-cash-out: FAQ
Sadly, no. The opening balance on your new mortgage usually needs to match the closing balance on your existing one. However, you may be allowed a slightly larger loan amount if you’re rolling closing costs into the new loan.
Yes. Cash-out refinance rates are typically 0.125-0.25 percent higher than rates for a comparable, no-cash-out refinance.
Yes. Some closing costs are calculated as a percentage of the sum you’re borrowing. And you’re borrowing more with a cash-out refinance, so your upfront fees should be higher.
That will vary based on your loan program. The maximum loan-to-value ratio for a conventional no-cash-out refinance is often 95-97 percent. FHA loans allow a refinance LTV up to 96.5 percent. And VA and USDA loans might allow up to 100 percent.
The maximum LTV for a cash-out refinance is usually 80 percent. But there are some exceptions to the rule. Notably, the VA cash-out refinance allows a maximum LTV of 100 percent, meaning eligible borrowers can cash out all their home equity.
No. Credit bureau Experian explains, “The cash you collect from a cash-out refinancing isn’t considered income. Therefore, you don’t need to pay taxes on that cash. Instead of being considered income, a cash-out refinance is simply a loan.” However, always check tax advice you read online with a qualified professional adviser before you rely on it.
Most cash-out refinance loans require a minimum credit score of 620 as well as stable income and employment, and a manageable debt load. In addition, you’ll usually need significantly more than 20 percent home equity to qualify.
What are today’s refinance rates?
Refinance rates are still low. And with home values skyrocketing nationwide, many current homeowners have seen unprecedented equity growth.
Whether you cash out or not, now is generally a smart time to refinance. But check all your options to make sure you’re getting the best deal on your new mortgage.