How Does Refinancing Work
Refinancing works by giving a homeowner access to a new mortgage loan which replaces its existing one. The details of the new mortgage loan can be customized by the homeowner, include the new loan’s mortgage rate, loan length in years, and amount borrowed. Refinances can be used to reduce a homeowner’s monthly mortgage payment; to take cash out for home improvements; and, to cancel mortgage insurance premiums, among other uses.
What Is A Mortgage Refinance?
A mortgage is a loan used for real estate. They’re available via banks, credit unions, and online lenders. Hundreds of billions of dollars worth of mortgage loans are given each year. But, mortgages are customizable not one-size-fits-all. For example, you can choose the number of years in your loan (i.e. term), the nature of your interest rate (i.e. fixed-rate or adjustable-rate), or even choose what you pay in mortgage closing costs. Your homeowner needs may be different from today to tomorrow. In the future, you may not like mortgage terms you created for yourself. Thankfully, you change your mortgage loan terms with a “refinance”. Refinancing your home means replacing your current mortgage loan with a new one. Refinances are common with rising or falling mortgage rates available from any bank not just your current mortgage lender. Homeowners refinance is to get a lower mortgage rate, to pay their home off more quickly, or, to use their home equity for paying credit cards or funding home improvement. Refinances typically close more quickly than a purchase mortgage loan and can require far less paperwork.
3 Types Of Refinance Mortgages
Refinance mortgages come in three varieties — rate-and-term, cash-out, and cash-in. The refinance type that’s best for you will depend on your individual circumstance. Refinance mortgage rates vary between the three types.
Rate-And-Term Refinance
In a rate-and-term refinance, the only terms of the new loan which differ from the original one are either the mortgage rate, the loan term, or both. Loan term is the length of the mortgage. For example, in a rate-and-term refinance, a homeowner may refinance from a 30-year fixed rate mortgage into a 15-year fixed rate mortgage; or, may refinance from a 30-year fixed rate mortgage at 6 percent mortgage rate to a new, 30-year mortgage rate at 4 percent. With a rate-and-term refinance, a refinancing homeowner may walk away from closing with some cash, but not more than $2,000 in cash. “No cash out” refinance mortgages allow for closing costs to be added to the loan balance, so that the homeowner doesn’t have to pay costs out-of-pocket. Most refinances are rate-and-term refinances — especially in a falling mortgage rate environment.
Cash-Out Refinance
In a cash-out refinance, the refinance mortgage may optionally feature a lower mortgage rate than the original home loan or shorter loan term, such as moving from a 30-year mortgage to a 15-year mortgage. However, the defining characteristic of a cash-out mortgage is an increase in the amount that’s borrowed. With a cash-out refinance, the loan balance of the new mortgage exceeds the original mortgage balance by five percent or more. Because the homeowners only owes the original amount to the bank, the “extra” amount is paid as cash at closing, or, in the case of a debt consolidation refinance, directed to creditors such as credit card companies and student loan administrators. Cash-out mortgages can also be used to consolidate first and second mortgages when the second mortgage was not taken at the time of purchase. Cash-out mortgages represent more risk to a bank than a rate-and-term refinance mortgage and, as such, carry more strict approval standards. For example, a cash-out refinance may be limited to a lower loan size as compared to a rate-and-term refinance; or, may require higher credit scores at the time of application. Most mortgage lenders will limit the amount of “cash out” in a cash-out refinance mortgage to $250,000.
Cash-In Refinance
Cash-in refinance mortgages are the opposite of the cash-out refinance. With a cash-in refinance, a refinancing homeowner brings cash to closing in order to pay down the loan balance and the amount owed to the bank.
The cash-in mortgage refinance may result in a lower mortgage rate, a shorter loan term, or both. The most common reason to do a cash-in refinance to get access to lower mortgage rates which are only available at lower loan-to-values. Refinance mortgage rates are often lower at 75% LTV compared to 80% LTV. Another common reason to cash-in refinance is to cancel mortgage insurance premium (MIP) payments. When you pay down your loan to 80% LTV or lower on a conventional loan, your mortgage insurance premiums are no longer due. Refinances Require Paperwork (But Not So Much) When you do a mortgage refinance, you are establishing a brand-new loan with brand-new terms. Typically, this subjects a refinance applicant to the same mortgage approval process as with a purchase mortgage applicant.
In other words, the refinance applicant is evaluated in three specific areas:
⦁ Credit Score and Payment History
⦁ Income and Employment History
⦁ Retirement Assets and Cash Reserves
Furthermore, also like a purchase, the home being refinanced is subject to a home appraisal in order to affirm its current market value. Despite the similarities, though, borrowers can usually expect to provide less documentation for a refinance mortgage as compared to a purchase. You will still be asked to provide proof of income using W-2s and pay stubs; proof of assets via bank statements; and proof of citizenship or U.S. residency status. But, you will not be asked to provide information related to the original transfer of the home. Refinance mortgages are often ready to “close” in 30 days or fewer.
Some Refinances Don’t Require Verifications
Refinance mortgages typically require the verification of a borrower’s income, assets, and credit. However, there are certain refinance programs for which verifications can be bypassed. These programs are called “streamlined” refinances. They’re called streamlined refinances because their underwriting requirements are grossly simplified and designed to be speedy. With a streamline refinance, mortgage lenders waive large parts of their “typical” refinance mortgage approval process. Often, home appraisals are waived, income verifications are waived, and credit scores verifications are waived. Different lenders may deploy different overlays for each of the streamlined programs, but the programs can be summarized as follows.
The FHA Streamline Refinance
The FHA Streamline Refinance is available to homeowners with an existing FHA mortgage. The FHA Streamline Refinance program waives all verifications and refinance mortgage rates are as low as with a standard-verification FHA-backed loan. The FHA Streamline Refinance requires refinancing homeowners to save five percent or more on their mortgage payment; and, to show a history of on-time payments to their lender. Cash-out refinance mortgages are not allowed via the FHA Streamline Refinance program.
The VA Streamline Refinance
The VA Streamline Refinance is available to homeowners with an existing VA-backed mortgage. Officially known as the VA Interest Rate Reduction Refinancing Loan (IRRRL), the VA Streamline Refinance also waives income, asset, and credit score verifications. Refinancing VA homeowners are required to demonstrate that the refinance mortgage will result in monthly payment savings, except for homeowners changing to a shorter loan term, such as from a 30-year mortgage to a 15-year mortgage; or, from an ARM to a fixed-rate loan. Homeowners may not receive cash-out as part of a VA Streamline Refinance.
The HARP Loan
The HARP loan is a government-backed refinance program good through December 31, 2016. Its official name is the Home Affordable Refinance Program. HARP is the Fannie Mae/Freddie Mac-equivalent of the FHA Streamline Refinance or VA Streamline Refinance. It’s a streamline refinance for conventional home loans. In order to qualify for a HARP loan, homeowners must a have a mortgage backed by Fannie Mae or Freddie Mac which predates June 2009; must show a 6-month history of on-time payments; and, may not have already used the HARP loan to refinance. HARP loans do not allow cash-out to the homeowners. Rate-and-term refinance mortgages only.
USDA Streamline Refinance Program
The USDA Streamline Refinance Program is available to homeowners with existing USDA home loans. USDA loans are loans for homeowners in rural or suburban areas which allow for up to 100% financing. The USDA Streamline Refinance Program does not verify income, assets or credit; and, homeowners using the program to refinance are limited to 30-year fixed rate mortgages and 15-year loans. ARMs are not allowed. Cash-out refinance mortgages are not allowed via the USDA Streamline Refinance.