Homeowners often face a critical decision when refinancing: should they pursue a cash-out refinance to tap into equity, or opt for a rate-and-term refinance to improve loan terms? The right choice depends on financial goals, equity position, and long-term plans. This comprehensive guide explains key differences, benefits, drawbacks, and real-life scenarios to help you decide which option aligns with your situation in 2025.
When it comes to refinancing, homeowners usually land on two main paths: cash-out refinance and rate-and-term refinance. While both options replace your existing mortgage with a new one, their goals are very different.
A cash-out refinance allows homeowners to replace their existing mortgage with a new, larger loan while withdrawing the difference in cash. The equity built up in the property essentially turns into accessible funds. This option is popular for funding renovations, consolidating debt, or covering large expenses like education or medical bills.
In contrast, a rate-and-term refinance is designed to optimize your mortgage terms without pulling equity. It helps you secure a lower interest rate, change your repayment timeline, or both. The aim here is purely financial efficiency—lower monthly payments, quicker equity building, and reduced total interest over time.
Real-Life Example:
- Maria in Phoenix refinanced her $250,000 mortgage into a $300,000 loan, pulling $50,000 in cash to upgrade her kitchen and bathroom. This was a cash-out refinance, giving her immediate liquidity to increase her home’s value.
- James in Chicago switched from a 30-year loan at 6.5% interest to a 15-year loan at 5.1%. This was a rate-and-term refinance, which helped him pay off his home faster and save tens of thousands in interest.
Refinancing has remained a hot topic in 2025 due to two major reasons: fluctuating interest rates and record-high home equity levels.
According to CoreLogic, U.S. homeowners gained more than $1.5 trillion in tappable equity in 2024, creating opportunities for cash-out refinancing. Meanwhile, even modest dips in mortgage rates have sparked waves of rate-and-term refinancing as homeowners try to secure better deals before rates climb again.
Common motivations for refinancing include:
- Reducing monthly payments for better cash flow
- Shortening loan term to build equity faster
- Accessing home equity without opening a HELOC
- Consolidating high-interest debt into a lower-rate mortgage
- Funding large expenses like tuition or home improvements
Opting for a cash-out refinance is usually about liquidity and financial leverage. If your home has appreciated in value and you’ve built substantial equity, cash-out refinancing can unlock that money.
Ideal Scenarios for Cash-Out Refinancing:
- Funding major renovations like adding an ADU (Accessory Dwelling Unit) or updating the kitchen and bathrooms
- Paying off high-interest credit card or personal loan debt
- Covering tuition costs without resorting to higher-interest student loans
- Covering unexpected medical expenses
- Investing in additional property or business opportunities
Caution:
While attractive, cash-out refinancing carries higher risks. By converting equity into debt, you increase your mortgage balance and potentially your monthly payments. If housing prices decline or financial hardship arises, you could be left underwater—owing more than your home is worth.
Real-Life Case:
A couple in Austin used a $60,000 cash-out refinance to remodel their home in 2021. Within two years, their property value increased by $95,000, making their decision profitable. However, another homeowner in Florida used cash-out funds to consolidate debt but later struggled with increased payments, underscoring the need for caution.
For homeowners focused on savings, stability, and efficiency, a rate-and-term refinance is often the smarter choice. Instead of accessing equity, this option restructures your loan for better terms.
Best Situations for Rate-and-Term Refinancing:
- Interest rates have dropped since your original loan
- You want to move from a 30-year mortgage to a 15-year mortgage for faster payoff
- You want to eliminate PMI (Private Mortgage Insurance) once you hit 20% equity
- You want to lock in predictable payments if you’re currently on an ARM (adjustable-rate mortgage)
- You’re planning to stay in your home long enough to recoup closing costs
Real-Life Example:
A Denver homeowner refinanced in 2023 from 7.2% to 5.9%. Even though the rate drop wasn’t dramatic, she saved $280 monthly. Over the life of the loan, she saved nearly $60,000 in interest, proving that even small rate changes can have big impacts.
| Feature | Cash-Out Refinance | Rate-and-Term Refinance |
|---|---|---|
| Goal | Access equity as cash | Improve loan terms |
| Loan Size | Larger than original | Same or smaller |
| Common Uses | Debt payoff, renovations, tuition, medical bills | Lower rates, shorten term, reduce PMI |
| Risks | Losing equity, higher payments, foreclosure risk | Closing costs, possibly paying more total interest |
| Best For | Homeowners needing liquidity | Homeowners seeking long-term savings |
Most lenders allow you to borrow up to 80% of your home’s value minus your existing mortgage balance.
Example Calculation:
- Home value: $400,000
- Current mortgage balance: $220,000
- Maximum refinance (80% of value): $320,000
- Available cash: $100,000
Cash-out limits vary depending on whether you choose a conventional, FHA, or VA loan. VA loans, for instance, may allow higher cash-out percentages under certain conditions.
Refinancing—whether cash-out or rate-and-term—comes with trade-offs.
Cash-Out Risks:
- Higher interest rates compared to rate-and-term refinances
- Larger loan balances and potentially higher payments
- Increased foreclosure risk if financial conditions change
Rate-and-Term Risks:
- Closing costs may outweigh monthly savings if you move soon
- Restarting a 30-year loan term may result in paying more total interest
- If not timed properly, refinancing during rate increases may lock you into higher costs
Refinancing isn’t free. Both types of refinancing involve closing costs, which generally range from 2% to 5% of the loan amount. These may include:
- Loan origination fees
- Appraisal fees
- Title search and insurance
- Attorney fees
- Recording fees
For a $300,000 loan, closing costs can be anywhere between $6,000 and $15,000. Some lenders allow you to roll these into your mortgage balance, but that increases long-term costs.
The break-even point tells you how long it will take for your monthly savings to outweigh your upfront costs.
Formula:
Closing Costs ÷ Monthly Savings = Break-Even (in months)
Example:
If you spend $6,000 on closing costs and save $250 per month, your break-even point is 24 months. If you plan to sell before that, refinancing may not make sense.
- Cash-Out Refinance: Can build wealth if funds are reinvested in home upgrades that boost property value or in high-return investments. However, misuse of funds (like vacations or luxury purchases) can erode long-term equity.
- Rate-and-Term Refinance: Usually builds wealth faster because it reduces interest payments and accelerates loan payoff. Over decades, this can save tens of thousands of dollars.
Q1. Is a cash-out refinance better than a HELOC in 2025?
A cash-out refinance gives a lump sum at fixed interest, making payments predictable. A HELOC offers flexible withdrawals, but most carry variable rates, so payments may rise. In 2025, homeowners seeking stability favor cash-out, while those valuing flexibility often prefer a HELOC.
Q2. Does refinancing hurt my credit score?
Yes, refinancing temporarily impacts your credit score due to a hard inquiry and new debt history. Typically, scores drop by a few points but recover within months if payments are made on time. Responsible management can even improve long-term credit health after refinancing.
Q3. How much equity do I need for a cash-out refinance?
Most lenders require at least 20% equity, meaning you must retain 20% ownership after borrowing. For example, if your home is worth $400,000, you should keep $80,000 in equity. This safeguard ensures lenders reduce risk and borrowers maintain financial stability.
Q4. Can I refinance with bad credit?
Yes, refinancing is possible with bad credit, but interest rates and terms may be less favorable. FHA and VA loans often provide more flexibility for borrowers with lower credit scores, making them attractive options. Improving credit before applying increases your chances of securing better terms.
Q5. Are refinancing rates higher in 2025?
Refinancing rates in 2025 remain volatile, influenced by inflation, Federal Reserve policies, and housing market shifts. They are generally lower than the record highs of 2023, making refinancing still attractive for many homeowners seeking savings. Rate fluctuations mean timing and lender shopping are key considerations.
Q6. Can refinancing eliminate PMI?
Yes, refinancing can remove private mortgage insurance (PMI) if your new loan balance is below 80% of your home’s appraised value. Eliminating PMI reduces monthly payments and overall borrowing costs, offering homeowners both immediate and long-term savings while building equity faster.
Q7. How soon after buying a home can I refinance?
Most lenders require a waiting period of six months before refinancing, but exceptions exist. Some loan programs allow earlier refinancing if it offers significant financial benefits. Always check with your lender about program-specific requirements to see if you qualify for early refinancing opportunities.
Q8. Can I refinance to shorten my term without raising payments?
Yes, if interest rates drop substantially, you may refinance from a 30-year to a 15-year mortgage without significantly raising payments. The lower rate offsets the shorter term, allowing you to build equity faster and reduce interest paid while maintaining manageable monthly costs.
Q9. Is a cash-out refinance taxable?
No, funds from a cash-out refinance are considered loan proceeds, not income, so they are not taxable. However, how you use the money can affect tax deductions. For example, home improvements may qualify for interest deductions, while personal expenses usually do not.
Q10. Should I refinance if I plan to sell in 3 years?
Refinancing typically makes sense if monthly savings outweigh upfront costs before selling. If you plan to move within three years, the break-even point may not be reached, making refinancing less beneficial. However, it can still be worthwhile in select cases with immediate, significant savings.
The choice between a cash-out refinance and a rate-and-term refinance boils down to your financial goals.
- Choose cash-out refinance if you need liquidity for renovations, debt consolidation, or major expenses, and are comfortable with added risk.
- Choose rate-and-term refinance if your priority is reducing monthly payments, saving on long-term interest, and building equity faster.