6 Min Read | December 22, 2022

What it Means to Refinance a Home Loan

There are two basic reasons for refinancing your home: to get more cash to spend now, or to pay less for your home over the long run.

Home Refinance


Refinancing comes in two types of home loans: cash-out and rate-and-term.

One is about raising cash, the other is about saving money.

Either way, it takes a lot of math to figure out whether refinancing will achieve your goals.

Refinancing is all about the math – and there’s a lot of it to figure out when considering whether to refinance your home loan. First, what’s your math problem? Do you want to refinance to get cash, by leveraging the value of your home? Or do you want to save money, by lowering the total cost of your mortgage?  


Next, get out the calculator. You’ll need to factor in refinancing fees, for example, in addition to interest charges (which you’ll probably end up recalculating a few times, as market trends drive rates up and down while you’re considering your home refinance options). This primer lays out key factors that can help determine whether refinancing makes sense for you.

Why Refinance a Home

Need cash? You may want to get what’s called a cash-out refinance. Americans had more than $29 trillion in home equity in 2022,1 about 40% of which is considered to be “tappable equity” (in other words, not already loaned as part of a mortgage and not more than 80% of the home’s value).2 You could be in a position to refinance if your home has tappable equity – and if the math works out for you.  


Want to lower the interest rate on your home loan? You could do what’s called a rate-and-term refinance. If your current home loan carries a higher interest rate than what’s available today, refinancing could save you money – again, only if the math works out.


Cash-Out Refinancing:

  • Goal: you walk away with cash
  • Taps into your home’s equity growth
  • Replaces your current mortgage with a bigger one

Rate-and-Term Refinancing:

  • Goal: you pay less for your house
  • Replaces your current mortgage with a lower interest rate and/or shorter repayment time

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.

What’s a Cash-Out Refinance?

A cash-out refinance involves replacing your existing mortgage with a new one whose 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 usually do cash-out refinancing when they want to make a home improvement, consolidate debt, or cover other large expenses or investments.   


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 – often 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.

What’s a Rate-and-Term Refinance?

Rate-and-term refinancing has a lot in common with cash-out refinancing, except that it’s about saving money rather than raising money. Technically, you get a new mortgage with a lower interest rate and/or shorter repayment schedule, to lower the total cost of your mortgage.  


Home refinancing interest rates may vary from rates for purchasing a home. For example, you might find that one lender advertises lower rates for refinancing than for purchasing, while another lender advertises the reverse (higher for a refinance, lower for a purchase). Typically, however, loan rates are personalized, via online applications and in-person discussions.  


In personalizing, lenders can factor in things like:

  • Your credit score.
  • Debt-to-income ratio.
  • Your home’s loan-to-value ratio (the amount of your loan as a percent of your home’s market value).
  • Even how many months’ worth of expenses you have in savings. 

As with the cash-out home refinancing, seemingly small differences in fees and interest rates can make a big difference here, too. By one calculation, someone holding a 30-year mortgage for $240,000 with a 7% interest rate could pay about $15,000 less, over the life of the loan, than someone with a 7.25% interest rate.

Timing Your Home Loan Refinance

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.3

The Takeaway

People refinance their home loans for two reasons: either to tap into the value of their home for cash or to save money by getting a new mortgage with better terms. The rewards and risks of this type of financing need to be analyzed carefully, to determine whether it’s the way for you to go.

Karen Lynch

Karen Lynch is a journalist who has covered global business, technology, finance, and related public policy issues for more than 30 years.


All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

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