A Guide to Mortgage Refinance Types: Which Option Is Best for You?

Refinancing your mortgage can be a powerful financial strategy, primarily used to secure a lower interest rate, reduce monthly payments, tap into home equity, or change your loan's term. The best refinance option depends entirely on your individual goals, whether that's saving money over the long term, accessing cash, or avoiding foreclosure. This guide breaks down the seven main types of refinance loans—from common rate-and-term refinances to specialized programs like the Fannie Mae HIRO—to help you make an informed decision based on your financial situation and home equity.

What Are the Most Common Reasons to Refinance a Mortgage?

Homeowners typically refinance to achieve specific financial objectives. According to industry data, a significant majority refinance to lower their monthly payment or interest rate. Other common goals include shortening the loan term to build equity faster, converting an adjustable-rate mortgage (ARM)—a loan with an interest rate that can change over time—to a stable fixed-rate mortgage, or accessing accumulated home equity for major expenses like home improvements or debt consolidation. Understanding your primary goal is the first step in choosing the right refinance path.

How Does a Rate-and-Term Refinance Work?

A rate-and-term refinance is the most straightforward type. It replaces your existing mortgage with a new loan that has a different interest rate, a different repayment term, or both. The principal loan balance typically remains the same. Homeowners often choose this option when market interest rates have dropped below their current rate. It can also be used to remove private mortgage insurance (PMI)—a monthly insurance premium required on some loans when the down payment is less than 20%—or to switch from a 30-year to a 15-year term.

• Common Qualifications: A minimum credit score of 620 is standard, along with proof of stable income and employment.

When Should You Consider a Cash-Out Refinance?

A cash-out refinance allows you to replace your current mortgage with a larger loan, receiving the difference between the two balances in cash. This lets you tap into your home's equity, but it also increases your total loan amount. Because mortgage rates are often lower than rates on personal loans or credit cards, a cash-out refinance can be a cost-effective way to fund large projects. There are generally no restrictions on how the cash is used.

• Key Consideration: Lenders usually require you to maintain a loan-to-value ratio (LTV)—the percentage of your home's value that is mortgaged—below 80% after the cash is taken out, meaning you need substantial equity.

What Is a Streamline Refinance?

A streamline refinance is designed for homeowners with existing government-backed loans (FHA, VA, or USDA). The process is simplified, often requiring less documentation and no home appraisal. The goal is typically to secure a lower interest rate with minimal hassle. It's important to note that you generally must refinance into the same type of government loan program.

• Primary Requirement: A strong history of on-time mortgage payments is the most critical factor for eligibility.

Can You Use a Cash-In Refinance to Build Equity?

The lesser-known cash-in refinance is the opposite of a cash-out refinance. You bring money to the closing to pay down your mortgage principal, resulting in a new, smaller loan balance. This strategy can help you quickly build equity, potentially eliminate PMI, and qualify for a better interest rate. It is often utilized by homeowners who have received a lump sum of money, such as an inheritance or bonus.

Is a No-Closing-Cost Refinance a Good Deal?

A no-closing-cost refinance eliminates upfront expenses, which typically range from 2% to 6% of the loan amount. Instead, the lender covers these costs in exchange for a higher interest rate on your new loan. This can be beneficial if you plan to sell or refinance again within a few years, as you avoid large upfront fees. However, if you keep the loan long-term, the higher interest rate will likely cost you more than the saved closing costs.

• Estimated Closing Costs: On a $300,000 loan, closing costs can range from $6,000 to $18,000.

What Are the Options for Homeowners Who Are Underwater?

For homeowners who owe more than their home is worth (being "underwater"), options are limited but exist. A short refinance involves a lender agreeing to forgive a portion of the mortgage debt and replace it with a new, smaller loan. This is a voluntary program for lenders and can be difficult to obtain. Alternatively, the Fannie Mae High LTV Refinance Option (HIRO) allows borrowers with a Fannie Mae-backed loan and less than 3% equity to refinance into a lower rate, even if they are slightly underwater.

To determine the best refinance option for you, carefully assess your primary goal, your current loan type, and your financial health. Key factors include your credit score, debt-to-income ratio, and the amount of equity you hold. Before committing, compare offers from multiple lenders to ensure you are getting the most favorable terms. Based on our experience assessment, the potential savings from a refinance can be significant, but it is crucial to calculate the break-even point—the time it takes for monthly savings to outweigh the closing costs—to ensure it’s a financially sound move for your situation.