Cash Out Vs Rate/Term Mortgage – What’s The Difference?

Has the terminology of mortgages taken you down? Don’t worry, understanding all the complicated phrases and vocabulary like “amortization” and “loan to value” is enough to intimidate any borrower. And, if you are considering refinancing your mortgage, get ready to learn new terms: “cash-out loan” and “rate/term refinance” continue reading.

The basics

Refinancing is a process of replacing your existing loan with a new one or merging two mortgages into one. Out with the old mortgage and in with the new, as it is popularly called. Once you refinance, your old loan is paid off, and a new one is put in its place.

Refinancing is a great way to save money, which everybody knows, but it also presents people with an opportunity to convert their variable rate mortgage into a fixed-rate loan, which is going to lock in low-interest payments, especially if rates seem likely to rise.

Two types of loans

There are two refinance loans. The simplest is rate/term refinancing, as no real money changes hands in this case, other than the fees associated with the loan. The mortgage size remains the same, as you trade in your current mortgage terms for newer and better terms. On the other hand, in cash-out refinance, the new mortgage will be greater than the old one. Besides the new loan terms, you will have more money in your wallet to pay off debts.

You can benefit from a rate/term refinance with a higher loan/value ratio. Cash-out mortgages come with more stringent conditions. If you have accumulated some funds in the form of cash, then it is likely to cost you something, but it all depends on how much equity you’ve built up in your home and your credit score.

But, a lower loan to value ratio along with a higher credit score can shift the numbers in your favor. Let’s assume, your credit score is around 750 and the loan-to-value ratio is less than 60 percent, then you won’t be charged additional cost for cash-out loan because such values make your lender believe that you won’t default especially when you have chosen term/rate refinance.

Your loan can be a cash-out loan even if you don’t get any money back. If you are paying off car loans, credit cards or anything else that was not part of your mortgage in the first place, the lender will likely consider it a cash loan. If you consolidate two mortgages into one, with the original one being a cash-out loan, then the new loan is also going to be a cash-out loan

Americans are divided on cash-out refinance

Although many experts advise decapitating your home of its equity in a cash-out refinance, recent data from various credible sources indicate that Americans prefer this type of loan at rates not seen since the financial crisis.

In cash-out refinance, not only do mortgage rates remain low despite rising interest rates, house prices have risen in many parts of the country to the point where homeowners have enough equity to make a worthwhile cash repayment. These higher loan-to-value ratios and improved personal balance sheets for Americans make it easier to qualify.

An interesting escape

You can generate some cash from your refinance without it counting as a cash loan (and incur additional fees) with the help of your mortgage broker. Basically, it works by taking advantage of the funds overlapping at the end of one loan and the beginning of another.