What it Means to Refinance a Home Loan

Whether you want a cash-out or rate-and-term refinancing, several details will be important to your refinance calculations. Actual costs and interest rates vary across time, location, lender, borrower, and type of loan. Many of the differences may seem slight – a fraction of a percent here or there – but the annual compounding of interest or the spreading of loan costs over time can make a difference of thousands of dollars in the total cost of a loan. Luckily, there are many loan calculators online that can help.

A cash-out refinance involves replacing your existing mortgage with a new one, where the amount is higher than what you currently owe, which is how you come away with cash in hand. This type of home loan competes with home equity lines of credit (HELOCs) and personal loans that are secured by using your house as collateral. People may do cash-out refinancing when they want to make a home improvement, consolidate debt, or cover other large expenses or investments.³

If you’re a homeowner with tappable equity, you still have to analyze whether a cash-out refinance is a good move. For example, a number of factors that drive up the costs associated with cash-out home mortgage refinancing – potentially in ways you might not expect. Interest rates could be higher because cash-out loans pose higher risk to the lender, and they may come with added fees or points. As with most loans, the size of your new mortgage could also carry a different repayment schedule than what you were paying before – and the longer the payment schedule, the higher the interest rate.

Remember, too, that there are associated risks. You could lose your collateral – your house – if you cannot keep up your payments. If housing prices drop, you could end up “under water,” with a loan that’s higher than your property value. Cash-out refinancing can also cause a dip in your credit score, but the effects are usually temporary if you make payments on time.⁴

But timing is everything, as the old saying goes. How long have you had your current mortgage? How much longer will you be staying in your home? Where are interest rates today, and where are they heading tomorrow?  

These calculations (and others) will determine whether refinancing is cost effective for you – and how much you could save. In a rate-and-term refinance, for instance, whether you achieve enough savings to cover your costs will depend on how long you remain in your home (and hold the loan). In addition, if you’ve had your current mortgage for a long time, you may be at the point where you’re more rapidly paying down principal. Getting a new mortgage means “resetting the clock” back to year one, in which most of each monthly payment applies to interest. One popular rule of thumb: If you can lower your mortgage interest rate by at least 1%, refinancing might be worth considering.⁵