Some borrowers consider a mortgage refinance at some point during their home loan terms. This is often the case when a borrower wants to take advantage of lower rates.
Refinancing is the process of getting a new mortgage loan to replace an old one. There is no one-size-fits-all refinance, so you need to be familiar with different options available to you.
1. Standard Mortgage Refinance
If you’re thinking about refinancing your mortgage loan, you might be eligible for a standard refinance. With this type of refinance, your mortgage lender requires a certain amount of equity in the home. In the past, lenders required at least 20% equity. Nowadays, you only need 20% equity if you want to avoid private mortgage insurance (PMI). Several loan programs only require a minimum of 5% equity. Depending on the type of loan, you need a minimum credit score between 500 and 620 to qualify for refinancing.
2. Cash-Out Refinancing
A cash-out refinancing is an option when you need to pull out some of your equity. Ordinarily, tapping your home’s equity involved selling the property. A cash-out refi offers the best of both worlds. You can refinance your mortgage loan and take advantage of affordable loan terms, plus borrow a percentage from your equity.
The money borrowed can be used for just about any purpose. This includes debt consolidation, home renovations, college expenses, a wedding or use the money to start a business. Unfortunately, cash-out refinancing doesn’t let you borrow 100% of your equity. For this type of refinancing, your lender may require at least 20% equity, but you might be eligible to borrow up to 80% of your equity. In other words, if you have $100,000 worth of equity, you can possibly borrow up to $80,000.
Understand that the amount you borrow doesn't only depend on your equity, but also your income. A cash-out refinance isn’t free money. Rather, it’s a loan that you repay the bank. Cashing out your home’s equity increases your mortgage balance, so you can expect your mortgage payment to increase. Also, a cash-out refinance decreases the amount of equity in your house. Using the above example, if you borrow the maximum of $80,000, your equity drops to $20,000.
3. Home Affordable Refinance Program (HARP)
Refinancing a mortgage loan and getting a lower interest rate can improve your financial outlook, especially if you're struggling to pay your current mortgage payment. But unfortunately, it’s difficult to refinance if you have an underwater mortgage. The Home Affordable Refinance Program (HARP) may provide relief. If you're eligible for this program, you can refinance up to 125% of your home’s value. Some mortgages do not qualify for this program. To be eligible, your mortgage loan must be guaranteed by Fannie Mae or Freddie Mac.
4. Short Refinance
If you don't qualify for HARP or a standard refinance, a short refinance may be an option, but only if it’s offered by your lender. If you're struggling to pay the mortgage—but you haven’t defaulted yet—your lender may agree to a short refinance to avoid a foreclosure and help you keep the property. This transaction is a combination of a short sale and a refinance. Your mortgage lender agrees to pay off the existing mortgage, and then replaces it with a new mortgage. The new mortgage reflects the current market value of the property. Let’s say you have a mortgage balance of $200,000, but your home’s only worth $170,000, The lender may pay off your balance and originate a new loan for only $170,000, which can put your mortgage payment within an affordable range.
Because the bank agrees to settle your mortgage balance for less than what you owed, your credit score will take a hit. But if you stay current with your new mortgage payment, you can slowly repair your credit score over the next couple of years. And with your negative equity gone, you can gradually build home equity.
5. FHA Streamline Refinance
If you have an existing FHA mortgage loan and you want to refinance to another FHA loan with less paperwork, an FHA streamline refinance might be an option. You can reduce the current mortgage rate on your home loan and benefit from a lower payment without an appraisal. There is no income or asset verification process, but there is a credit check and your mortgage must be in good standing. This is one of the fastest ways to refinance an existing FHA mortgage.