Home loan refinancings typically fall into one of two categories: cash-out or no-cash-out. A cash-out refinance lets you swap your existing mortgage for a bigger one, so you can access extra cash. With a no-cash-out refinance, on the other hand, you replace your existing loan with a new one that has a different (usually lower) interest rate or term, but you generally don’t get any cash back. If you’re contemplating refinancing your mortgage, here’s what you need to know to help you decide between a no-cash-out and a cash-out refinance.
What Is a No-Cash-Out Refinance?
A no-cash-out refinance, also called a “rate and term refinance,” is a way to switch your current home loan for a new one with a different interest rate and/or term. A no-cash-out refinance is a good option for people who can qualify for a lower interest rate, resulting in a lower monthly payment. It may also be a good choice for people who want to switch to a shorter-term loan (like going from a 30-year mortgage to a 15-year mortgage). Other reasons for refinancing could be to swap an adjustable rate mortgage (ARM) for a fixed rate mortgage, or go from an FHA loan (with mortgage insurance) to a conventional loan. With a no-cash-out refinance, the borrower is responsible for covering the closing costs out of pocket. Closing costs can also be rolled into the new loan, which can increase the amount you owe, known as the principal. Contrast that to a cash-out refinance, where on top of paying off your old loan, you also borrow additional funds from the equity in your home, which you then receive as a lump-sum cash payment at closing. That amount gets tacked onto the new loan, which also increases the principal. Keep in mind, the application process and borrower eligibility requirements may be more stringent for a cash-out refinance, because the risk to the lender is higher. With a cash-out refinance, you’re borrowing additional money, therefore, your payment obligation is higher. In the lender’s eyes, this means you have a greater potential to default on the loan. Typically, the process and eligibility requirements are more lax with a no-cash-out refinance, since in most cases, you’re not borrowing additional money. As such, the risk to the lender is much lower.
No-Cash-Out Refinance vs. Cash-Out Refinance
Just like a no-cash-out refi, limited-cash-out borrowers can roll any closing costs, fees, and mortgage points into the new loan, as well as receive a small cash payment. However, with a limited cash-out refinance, the cash at closing cannot exceed $2,000 or 2% of the total new loan amount, whichever is less. Contrast that with a Freddie Mac no-cash-out refinance, which allows you to take $2,000 or 1% of the new total loan amount, whichever is more, at closing.
When to Choose a No-Cash-Out Refinance
A major decision that most borrowers must make up front is which type of refi to choose. Here are some scenarios when the no-cash-out option may be the better move:
You want to lower your interest rate: Lenders can tell you if you qualify for a lower rate, and if you’ll save money on your monthly mortgage payment. You want to move from an ARM to a fixed-rate loan: Especially in a low-rate environment, it could be a good idea to lock into a favorable rate and walk away from the uncertainty of an adjustable rate mortgage.You want to shorten the loan term or switch loan programs: There are times when it may make financial sense for you to move from a 30-year to a shorter-term loan (like a 20-year or a 15-year). Since shorter-term mortgages usually offer lower interest rates, you may be able to save a significant amount of money over the life of the loan without increasing your monthly payment too much—say, if you’re gearing up for retirement and want to pay off your home more aggressively. In that case, a no-cash-out refi may be a smart move. In other instances, you may want to move out of an FHA loan (which requires that you to pay mortgage insurance) into a conventional loan.You want to increase your odds of approval. With a no-cash-out refinance, you’re not taking out a large amount of extra cash, so that may make it easier to get approved for the loan for a couple of reasons. For one, you don’t need as much equity in your home. And you may not even need a home appraisal to refinance. On the other hand, a cash-out refinance increases the amount of your loan. This creates more risk for the lender, so the requirements tend to be tougher. You typically need to get your home appraised and have an above-average credit score to qualify, making it potentially more challenging to get approved.
When a Cash-Out Refinance Might Be Better
There are some situations when it makes sense to go with a cash-out refinance, even though it increases the overall loan amount. Walking away with a significant cash payment could help borrowers in a number of scenarios, including:
Making upgrades, repairs, or home renovationsPaying off high-interest debt Taking advantage of significant interest rate declines without dramatically increasing monthly mortgage payments
It’s really up to you. There are no restrictions on how you can use your lump-sum payout from a cash-out refinance.
The Bottom Line
If you have ample equity and some financially sound reasons for taking out the extra cash (like removing a debt burden or increasing your home’s value with an upgrade), then a cash-out refinance could be beneficial and cost effective. But remember, that route may involve a more stringent application process, a higher interest rate, and a greater cost (and risk) to you on a monthly basis and over the long run. For the majority of borrowers, pursuing a no-cash-out refinance is often the simpler, less risky route (since you’re not taking on extra debt), and you have a greater likelihood of being approved.
