What are the types of refinancing?
All mortgage refinance types accomplish essentially the same goal -- to obtain a new loan on your property to replace your existing loan. But there are several different types of refinancing, and the right one depends on your situation.
READ MORE: The Truth About Refinancing Your Mortgage
Rate and/or term refinancing
Two very common reasons to refinance are to lower the interest rate on a mortgage, or to change the repayment term. And while these can be separate events, they usually happen simultaneously.
As a personal example, I originally obtained a 30-year fixed-rate mortgage at 4% interest on my home when I bought it in 2015. After paying the loan for five years, interest rates fell to all-time lows shortly after the onset of the COVID-19 pandemic. I decided to refinance at 3% interest with a new 30-year fixed-rate mortgage. At that point, I had 25 years left on the loan term. So, not only did my interest rate drop, but my loan's repayment time period is now five years longer than it would have been if I'd kept the original loan.
The primary goal of this type of refinance is typically to either lower the monthly mortgage payment or lower the total interest cost of the loan. It's important to make sure the monthly payment savings will justify the closing costs of the loan over time. Most borrowers roll the closing costs of refinancing into the loan, so the principal amount of your refinancing loan is likely to be slightly higher than your original mortgage.
As a general rule, refinancing could be worthwhile if both the following are true:
- You qualify for an interest rate that's at least 75 basis points (0.75%) lower than you currently pay
- You're planning to live in the home for several more years
Check out today's refinancing rates to find out if you could save money on your home loan.
FHA refinancing
An FHA loan is a type of mortgage insured by the Federal Housing Administration (FHA). FHA loans can also be used for both purchase mortgages and refinance mortgages. Borrowers can use an FHA loan to do a rate and/or term refinance. They could also do a cash-out refinance, which we'll cover in the next section. Existing FHA borrowers could qualify for an FHA streamline refinance, which requires less documentation and underwriting than a full refinance.
FHA loans come with additional mortgage insurance fees. As such, if you can qualify, you can usually save money by refinancing an FHA loan with a conventional loan (which, in many cases, will not have mortgage insurance fees).
To be clear, FHA loans are originated by mortgage lenders such as banks -- not by the FHA itself. In fact, many lenders will give you refinancing quotes on an FHA refinance and a conventional refinance when you apply to see which might be the better option.
Check out our guide to FHA loan refinancing for more information.
Cash-out refinancing
As the term implies, cash-out refinancing is a type of refinancing mortgage loan where you receive cash back at closing. The cash-out refinancing process involves taking out a loan for more than you owe on your home and receiving the difference in cash.
As a simplified example, let's say you owe $300,000 on your existing mortgage. You could obtain a refinancing mortgage for $400,000 and receive $100,000 in cash at closing (less any fees and closing costs). The downside is that your debt (and potentially your monthly payment) will be significantly higher, so keep that in mind.
A cash-out refinance can also be used to lower the interest rate and change the term of the loan.
HELOC refinancing
HELOC stands for "home equity line of credit" and is a way to pull cash out of your home without getting rid of your existing mortgage. Technically, this isn't a refinance loan as you're not replacing your current mortgage. However, it's still worth mentioning as an alternative.
Generally, the mortgage rate you can get on a cash-out refinance will be higher than you could get on a simple rate-and-term refinance from a refinance lender. If you already have a mortgage with a low interest rate, it can be smart to use a separate funding vehicle to tap into your home's equity. It's worth noting that HELOCs typically have variable interest rates, which can actually work to your advantage if rates fall, but can make your cost of borrowing more expensive when rates rise.
Another advantage of a HELOC is that you only borrow (and pay interest on) the money you need. If you get a $100,000 HELOC from your lender, but only withdraw $20,000 to finance a home improvement project, you'll only pay interest on the money you withdrew.
Note: HELOCs differ from home equity loans. For more on which is right for you, visit our comparison of a home equity loan vs. HELOC. We've also created a list of the best home equity loan lenders.
