Homeowners choose to refinance their home loans for a variety of reasons, including to pay off bills, do home renovations or repairs, or save money by lowering the interest rate or monthly mortgage payment.
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.
Despite its name, with a no-cash-out refinance borrowers may receive cash payments at closing. For a loan backed by Freddie Mac, these payments are capped at 1% of the new total loan amount or $2,000, whichever is greater, and are added to 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
|No-Cash-Out Refinance||Cash-Out Refinance|
|Loan Principal||Remains the same (except for any closing costs or fees rolled into the loan)||Grows the principal by the amount of cash borrowed|
|Reasons for Refinancing||Lower interest rate, shorten loan term, or switch to a different loan program||Use home equity to get cash out for various purposes, such as consolidating and paying down debt or home renovations or repairs|
|Cash Payment Provided to Borrower||Yes, for a limited amount
For Freddie Mac-backed mortgages, cash payments are capped at 1% of the new total loan amount or $2,000, whichever is greater
For Fannie Mae-backed mortgages, cash payments are limited to 2% of the new total loan amount or $2,000, whichever is less
|Eligibility Requirements||Over 95% loan-to-value (LTV) ratio (the home’s current value vs. the principal amount of the loan)||More than 20% equity in home; LTV ratio of 80% or less|
|Interest Rates||Often lower than previous loan||May be higher than previous loan|
No-Cash-Out vs. Limited Cash-Out Refinance
In addition to cash-out and no-cash-out, you may come across the term “limited cash-out refinance.” This is the term Fannie Mae uses for no-cash-out refinancings, and it essentially works the same way. The application process for a limited cash-out refi is similar to a Freddie-Mac-backed no-cash-out refi, but there are a couple of minor distinctions.
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.
If you’re not sure which entity backs your loan, or if you need help understanding the unique requirements of your various refinance options, your best bet is to speak with your broker or lender who can break down the details.
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 renovations
- Paying 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.
Remember, when you take a cash-out refinance loan, you’re using your home as collateral. Make sure you’re not taking on more debt than you can handle, since you could lose your home if you fall behind on payments.
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.
Frequently Asked Questions (FAQs)
How much does it cost to refinance a mortgage?
Refinancing a mortgage involves closing costs, similar to what borrowers pay when they purchase a home for the first time. Though costs vary, you could expect your closing fees to be between 3% and 6% of the loan amount.
How often can you refinance a mortgage?
You can refinance your mortgage as often as you like, assuming you can qualify, although it is rarely cost effective to do so since you’ll have to pay closing costs every time. However, it could be worth it if there are major interest rate drops. For example, according to Freddie Mac, repeat refinances (defined as two or more refinance loans in a one-year period) accounted for 10.1% of refinances in 2020, when interest rates fell to record lows.
When does it make sense to refinance a mortgage?
If you’re not planning a move for the foreseeable future and have strong credit and stable income, refinancing can make sense if you can access a more favorable interest rate or better loan terms (like removing private mortgage insurance or shortening the length of the loan).
How long does it take to refinance a mortgage?
Processing a refinance application typically takes one to two months. Due to lower interest rates and higher demand, the average time to close a refinance loan in 2021 has been more than 50 days, according to ICE Mortgage Technology’s Origination Insight Report.
Freddie Mac. “No-Cash-Out Refinance Mortgages.”
The Federal Reserve Board. "A Consumer's Guide to Mortgage Refinancings: What Will Refinancing Cost?"
Freddie Mac. "Refinance Trends in 2020."
ICE Mortgage Technology. "May 2021 Origination Insight Report."