Cash Out vs Rate and Term Refinance

Introduction

When you refinance, you replace your existing mortgage with a new one. The two main types are rate-and-term refinance and cash-out refinance. Understanding the difference helps you choose the right option for your situation. A rate-and-term refinance changes your interest rate or loan term without taking cash—your new loan amount equals (or is less than) what you owed. A cash-out refinance lets you borrow more than you owe and receive the difference in cash, increasing your loan amount and typically your mortgage payment.

Federal rules—including the Truth in Lending Act (TILA), the Real Estate Settlement Procedures Act (RESPA), and TRID (TILA-RESPA Integrated Disclosure)—require lenders to provide a Loan Estimate within 3 business days of application. This form shows your loan amount, interest rate, mortgage payment, and closing costs for the refinance you are considering. Comparing a rate-and-term and cash-out scenario (if you are weighing both) can help you see the cost difference.

This guide explains cash-out vs rate-and-term refinancing, how each works, and what first-time refinancers should know. For more detail, see What Is a Rate and Term Refinance, What Is a Cash Out Refinance, and Refinance vs HELOC.

What This Means

With a rate-and-term refinance, your new loan amount pays off your existing mortgage—plus any closing costs you roll in—and you receive no cash at closing. You are refinancing to get a lower interest rate, a different loan term (e.g., 30 years to 15 years), or both. Your mortgage payment may go down (if the rate drops or you extend the term) or up (if you shorten the term). Your loan-to-value ratio (LTV) typically stays the same or improves slightly.

With a cash-out refinance, your new loan amount exceeds what you owe. The difference—minus closing costs—is paid to you at closing. You are tapping your home equity. Your loan amount increases, so your mortgage payment increases. Your LTV goes up because you are borrowing more relative to the home's value. Lenders often have stricter LTV limits for cash-out (e.g., 80% for conventional) and may charge slightly higher interest rates.

FHA streamline and VA IRRRL refinances are typically rate-and-term only—they do not allow cash-out. If you want to tap equity and have an FHA or VA loan, you would need a full cash-out refinance, which has different underwriting and eligibility rules.

How It Works

For both types, the lender will underwrite your application—verifying income, assets, credit, and the property. For a rate-and-term refinance, the lender confirms your current balance and that the new loan amount does not exceed the payoff plus allowable fees. For a cash-out refinance, the lender also verifies the property value (usually with an appraisal) and applies LTV limits. Your debt-to-income ratio (DTI) must support the new mortgage payment.

Conventional cash-out refinances often cap LTV at 80% (or lower in some cases)—meaning you can borrow up to 80% of the home's value. If your home is worth $400,000 and you owe $250,000, you have $70,000 in equity above an 80% LTV ($320,000). You could potentially take up to $70,000 in cash-out, minus closing costs. Rate-and-term refinances may allow higher LTV (e.g., 97% for some programs) because you are not increasing the loan amount beyond the payoff.

Your Loan Estimate will show the loan amount, interest rate, mortgage payment, and closing costs. For a cash-out refinance, the form will also show the amount of cash you will receive. Under TRID, you receive the Loan Estimate within 3 business days of application. Compare the payment and total cost for a rate-and-term vs cash-out scenario to see how much the extra borrowing adds to your mortgage payment. See What Is Amortization and What Is Mortgage Principal for context on how payments apply over time.

Closing costs are similar for both—appraisal, title, lender fees, etc. With cash-out, the appraisal is typically required to establish value. With rate-and-term, some streamline programs waive the appraisal. You can often roll closing costs into the loan amount for either type, which increases your balance and payment slightly.

Realistic Example Scenario

David owes $280,000 on his home. It is worth $400,000. He is considering two options: a rate-and-term refinance to lower his rate from 7% to 6.25%, or a cash-out refinance to get $30,000 for a kitchen remodel while also lowering his rate.

Rate-and-term: New loan amount = $280,000 (plus $5,000 in closing costs rolled in = $285,000). At 6.25%, his mortgage payment (principal and interest) is about $1,755. He receives no cash at closing.

Cash-out: New loan amount = $280,000 + $30,000 cash + $5,500 closing costs = $315,500. At 6.5% (slightly higher rate for cash-out), his mortgage payment is about $1,995. He receives $30,000 at closing. His LTV is 79% ($315,500 ÷ $400,000), within typical limits.

The cash-out option costs David about $240 more per month than the rate-and-term option. He must decide whether the $30,000 for the remodel is worth the higher payment. If he does not need the cash, the rate-and-term refinance is the simpler, lower-cost path.

This example is illustrative. Actual interest rates, closing costs, and LTV limits vary by lender and program. David's scenario shows the trade-off: cash-out gives you access to equity but increases your loan amount and mortgage payment.

Why This Matters for Homebuyers

If you have built equity in your home—through appreciation or paying down principal—you may be able to access it through a cash-out refinance. Common uses include home improvements, debt consolidation, education, or emergency expenses. A rate-and-term refinance, by contrast, is focused on lowering your interest rate or changing your term. It does not give you cash—it may lower your mortgage payment or help you pay off the loan sooner.

For many homeowners, a rate-and-term refinance is the right choice when rates drop. You reduce your payment or shorten your term without increasing your debt. A cash-out refinance makes sense when you need funds and are comfortable with a higher loan amount and mortgage payment. Your Loan Estimate will show both scenarios if you request quotes for each—use it to compare.

Alternatives to cash-out refinance include a HELOC (home equity line of credit) or a home equity loan. These are second liens—you keep your existing mortgage and add a separate loan or line. They may have different interest rates, terms, and closing costs. Compare all options before deciding.

Pros and Cons

Common Mistakes

• Taking more cash than you need: Every dollar you take out increases your loan amount and mortgage payment. Borrow only what you need.
• Ignoring the payment increase: Cash-out raises your payment. Ensure your budget can handle it—especially if you use the cash for something that does not generate income (e.g., a vacation).
• Assuming streamline allows cash-out: FHA streamline and VA IRRRL typically do not allow cash-out. If you need cash and have an FHA or VA loan, you need a full cash-out refinance.
• Not comparing to HELOC: A HELOC may be cheaper if you need flexibility or a smaller amount. Compare interest rates, closing costs, and terms.
• Overlooking the break-even: Refinancing has closing costs. For rate-and-term, calculate when monthly savings offset the cost. For cash-out, the benefit is the cash—but the higher payment is a real cost.

Frequently Asked Questions

What is the main difference between cash-out and rate-and-term refinance?

Rate and term: you refinance for the payoff amount (or less) and change your interest rate or loan term. Cash-out: you borrow more than you owe and receive the difference in cash. Your new loan amount is higher with cash-out.

When is cash-out refinance used?

When you need funds for home improvements, debt consolidation, education, or other expenses. You tap home equity. The cash you receive is the difference between your new loan amount and what you owed on the old loan.

Which has stricter underwriting?

Cash-out often has stricter LTV limits, credit requirements, and may have higher interest rates. Rate and term can be simpler, especially for FHA streamline and VA IRRRL programs, which typically do not allow cash-out.

Can I do a small cash-out?

Yes. Some borrowers take a small amount of cash out (e.g., to cover closing costs or a minor expense) while primarily doing a rate-and-term refinance. The loan is still classified as cash-out, which may affect LTV limits and pricing.

How does cash-out affect my mortgage payment?

Cash-out increases your loan amount, so your monthly mortgage payment is higher than it would be with a rate-and-term refinance. The more you take out, the higher the payment.

Should I consider a HELOC instead of cash-out?

A HELOC is a separate line of credit secured by your home. It may make sense if you need flexibility or want to borrow only what you need over time. Compare the costs and terms. See Refinance vs HELOC for more.

Sources

• Consumer Financial Protection Bureau (CFPB) – Loan Estimate and Closing Disclosure (TRID)
• Consumer Financial Protection Bureau (CFPB) – Truth in Lending Act (TILA)
• Fannie Mae – Selling Guide (conventional refinance guidelines)
• Freddie Mac – Single-Family Seller/Servicer Guide