If you’re a homeowner, you’re probably wondering if there’s a way to get a better deal on your mortgage. After a couple of years of homeownership, you may have better credit and more income than you did when you first bought your home. So why not get a better mortgage than the one you started with?
In this guide, you’ll learn about the different types of refinance options available, the benefits and drawbacks of each option and how to determine which one is right for you.
Rate and Term Refinance
One of the most common types of refinancing is known as rate and term refinancing. This is probably the simplest form of refinancing because you’re only borrowing enough to pay the current balance on your mortgage. At the same time, you may be able to:
- Get a better interest rate: By securing a new interest rate, even if it’s a single percentage point better than what you have now, you may be able to reduce your mortgage payments by several hundred dollars per month.
- Adjust your loan term: If you can afford to make a larger mortgage payment, you can refinance your loan so you can pay off your mortgage in less time. Or if you need to lower your monthly payment, you can take out a new mortgage for a longer period of time.
Anyone who has a mortgage can apply for a rate and term refinance. However, it usually makes the most sense when:
- Mortgage rates are lower than when you first took out your mortgage.
- You’ve improved your credit and income, making it more likely that you’ll get a better interest rate.
A cash-out refinance lets you convert your equity into cash. Your home equity is the difference between the appraised value of your home and the current balance of your mortgage loan.
Every month you make a mortgage payment, a portion of that payment pays down the balance of your mortgage loan. The more you pay off, the more home equity you can build.
With a cash-out refinance, you borrow more money than you currently owe on your mortgage and pocket the remaining money for yourself.
How does that work? Let’s say you’ve been paying your mortgage for a few years, and home prices have gone up in your area. Your home has been appraised at $300,000, and you have $200,000 remaining on your mortgage. That means you have $100,000 in equity.
However, most lenders will only let you borrow against 80% of your home’s value. So you’d only be able to borrow up to $240,000. But that still leaves you with $40,000 in equity that you could access with a cash-out refinance.
A cash-in refinance is the opposite of a cash-out refinance. With a cash-in refinance, you can convert cash into equity. This allows you to own a larger portion of your home while also helping you get a lower interest rate.
In addition to getting a lower interest rate, a cash-in refinance can help you reduce or end the need for private mortgage insurance (PMI).
If you put less than 20% down when you bought your home, you may have had to pay for PMI every month. PMI can add between $30 – $70 per $100,000 borrowed to your mortgage payment and you’ll usually be required to pay that every month until you’ve built at least 20% equity in your home.
However, if your home has increased in value, refinancing may put you closer to that 80% threshold. Add a little more cash with a cash-in refinance, and you may be able to end your PMI for good.
Some of the refinancing options mentioned above will carry closing costs. These closing costs might include the loan origination fee, appraisal fee and other fees charged by the lender, which may cost you a few thousand dollars out of pocket when you refinance.
With a no-closing-cost refinance, these costs can’t be avoided. But they can be tacked onto your new mortgage loan so you don’t have to access your personal cash reserves.
However, homeowners who pursue this option should expect to pay higher interest rates and, in some cases, end up paying more overall.
Streamline Refinance for Government-Backed Mortgages
If your mortgage is backed by the federal government, then you may be able to qualify for a streamline refinance. Assuming you already have an existing loan with the Federal Housing Administration (FHA), Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA), a streamlined refinance can help you avoid some of the underwriting and documentation requirements you’d typically find in the private sector. This can help significantly reduce the total cost of refinancing.
FHA Streamline Refinance
An FHA Streamline Refinance is reserved for homeowners who already have a mortgage through the FHA. All FHA homeowners are allowed to apply for an FHA Streamline Refinance, which has limited (or no) costs, no credit check or job verification and may even allow applicants to receive a refund for some of their PMI payments.
VA Streamline Refinance
The VA Streamline Refinance, also known as a VA IRRRL, is available for homeowners whose mortgages are backed by the VA. Like other streamlined refinance options, VA streamlines require limited amounts of paperwork and underwriting.
Additionally, most VA-backed homeowners can usually lock in a lower interest rate than they would find within the private sector. To qualify for a VA Streamline Refinance, homeowners will usually need to have made 12 consecutive on-time payments.
USDA Streamline Refinance
The USDA Streamline Refinance is often the most efficient refinancing option for anyone who already has an existing mortgage backed by the USDA. Like its FHA and VA counterparts, USDA Streamline Refinancing has an extremely limited underwriting process – you just need to have a qualifying loan and will usually need to have made 12 consecutive on-time payments.
Accessible Refinance Programs
In addition to the government agencies that offer streamlined refinancing options, several other programs allow borrowers to access refinancing options that might otherwise be out of reach.
Freddie Mac’s Enhanced Relief Refinance℠
If you have an existing loan backed by Freddie Mac, using an Enhanced Relief Refinance℠ can help you secure a lower interest rate or make other changes to your mortgage. The program is ideal for people who have been up to date with their mortgage payments but have had trouble refinancing because their property values are declining.
Fannie Mae’s High LTV Refinance Option
The Fannie Mae High LTV Refinance Option is another refinancing option supported by the government. This program is available for people who want or need to refinance but don’t have enough equity in their homes to pursue a traditional refinancing option. It is ideal for people who currently have less than 20% equity in their home.
A short refinance is a refinancing option that can be accessed by people who are currently defaulting on their mortgages. Essentially, short refinancing replaces your current mortgage with one the lender believes you will be more likely to pay – this helps the lender avoid the costly process of foreclosing on your home while also allowing you to keep living there and building equity.
How To Choose Your Ideal Refinance Option
With many different refinancing options available, it can be difficult to know which will be right for you. However, by asking yourself just a few simple questions, you should be able to narrow down your options.
What kind of borrower are you?
If you apply for refinancing – unless you are applying for a streamlined refinance – lenders will want to take a close look at your credit profile. If your credit score has improved, your debt-to-income ratio has improved or you’ve accumulated more equity in your home, then you will have a lot more options to choose from.
How much equity do you have?
Generally speaking, private lenders will want to make sure you have at least a 20% equity share in your home. Once you reach this seemingly “magic” cutoff, you’ll be able to apply for a cash-out refinance and explore various other options.
Who backs your existing mortgage?
If your current mortgage is backed or otherwise supported by a government agency, your best bet will be with a program such as the FHA Streamline, VA IRRRL or USDA Streamline. If you have a conventional mortgage, your best options may be a standard refinance through your lender or the Freddie Mac Enhanced Relief Refinance℠ or Fannie Mae’s High LTV Refinance Option.
What options does your current lender offer?
While you should take the time to explore different refinancing options, the most natural place to begin the process is with your current lender. Check to see if your current lender offers the refinancing options you’re interested in securing and, if they don’t, you can always extend your search elsewhere.
The Right Refinance for You
Even though your mortgage might say “30 Years” at the top, that doesn’t mean your current situation has to be permanent. Refinancing is a great option for people who are looking to secure a lower interest rate or access equity in their homes. Additionally, simply knowing this option is available, if you ever need it, can help provide a little bit of relief.
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Freddie Mac. “Breaking Down Private Mortgage Insurance (PMI).” Retrieved June 2022 from https://myhome.freddiemac.com/buying/breaking-down-pmi
U.S. Department of Veterans Affairs. “Interest rate reduction refinance loan.” Retrieved June 2022 from https://www.va.gov/housing-assistance/home-loans/loan-types/interest-rate-reduction-loan/
U.S. Department of Agriculture. “Streamlined Assist Refinance Loans.” Retrieved June 2022 from https://www.rd.usda.gov/files/RD-RHS-SFHStreamlinedAssistRefinanceLoans.pdf