For those thinking of refinancing their mortgage, there are options. Learn more about the different types of refinancing.
There are many reasons why you might want to refinance your mortgage. Maybe interest rates have gone down and you want to snag a lower rate. Or perhaps you want to convert some of your home equity into cash. Refinancing can even help you eliminate costly private mortgage insurance.
No matter your reason for refinancing, it’s important to choose the right type of loan for your goals. Below, we’ll review five different types of refinance loans so you can choose the one that’s right for you as a borrower.
What Is Mortgage Refinancing?
Before we dive into the different types of refinance mortgage loans, let’s define what refinancing is.
Refinancing is the process of paying off your current mortgage loan with a new mortgage loan. This new loan will have a new set of terms based on your current financial situation.
Depending on your goals, you can refinance to try to get a loan with:
- A lower interest rate
- A lower monthly payment
- A shorter loan term (so you can pay off your mortgage faster)
- A larger loan amount (to convert some of your home’s equity into cash)
- No private mortgage insurance requirement
Mortgage Refinancing Loan Requirements
Even though refinancing may help you improve the terms of your mortgage, it all depends on your current eligibility. You’ll only qualify for better terms if your financial situation has improved or if market conditions have changed since you took out your original mortgage.
You will also need to meet specific home equity requirements to be eligible. Many lenders require you to have at least 20% equity in your home.
If your financial situation has gotten worse or you have too little equity, you may want to hold off from refinancing and seek alternative ways to achieve your goals, which we’ll dive into further.
What Are the Different Types of Refinance Loans?
Now that we’ve explained how mortgage refinancing works and why it’s worthwhile, let’s take a look at five different refinancing options and the loan type that works best for you.
1. Traditional (Rate-and-Term) Refinance Loan
Rate-and-term refinancing, also known as traditional refinancing, is the most common type of refinance loan. It works by replacing your existing mortgage with a new one for the same amount. While your conventional loan amount will remain the same, you’ll receive a new mortgage rate and loan term, based on your current eligibility (hence the name “rate-and-term”).
Most homeowners pursue a traditional refinancing option to save money on interest or to obtain more affordable monthly payments. Here’s how this form of refinancing can help you achieve these goals:
- You may be able to get to a lower mortgage rate – If interest rates have gone down recently or your credit score has improved, you may be eligible for a lower interest rate at this time. Switching to this lower interest rate can save you significant money over the lifetime of your loan. However, if you have been neglecting your credit card and attempt to refinance with bad credit and late payments, getting a lower interest rate is unlikely.
- You can refinance to a different loan term – You can also use rate-and-term refinancing to adjust your loan term, whether you prefer a:
- Shorter loan term – By switching to a shorter loan term, you can pay off your mortgage faster. You’ll also save money on interest since shorter loan terms have fewer interest payments. As an added bonus, refinancing to a shorter loan term may help you qualify for a lower interest rate.
It’s important to note that switching to a shorter loan term will most likely increase your monthly payment amount (depending on how your interest rate is impacted). As long as you can afford these higher payments, you’ll benefit financially from the reduced interest expense.
- Longer loan term – If you’re struggling to afford your current mortgage payments, you may be interested in extending your loan term instead.
By spreading your remaining loan balance over a longer span of time, your monthly payments will become more affordable. However, you’ll owe more interest on your mortgage than you would owe otherwise.
Rate-and-term refinancing is available with a conventional loan, FHA loan, VA loan, and USDA loan mortgages. You can also use this form of refinancing to switch mortgage types. For example, you could go from an FHA mortgage to a conventional mortgage.
2. Cash-Out Refinance Loan
Some homeowners choose to refinance their mortgage with the goal of converting equity into cash. If you want to liquidate some of your home equity, you can do so with a cash-out conventional refinance loan.
A cash-out refinance option is when you replace your existing mortgage loan with a new mortgage loan for a larger amount. This allows you to “cash-out” the difference between your existing loan and new loan. You can use this money however you like, whether you want to finance a home improvement project or consolidate your debt.
When referring to a VA refinance loan, this is the same as a cash-out refinance loan, but specifically for veterans, active duty, reserve, and national guard members who qualify.
As with traditional refinancing, cash-out refinancing also gives you the chance to adjust your loan terms.
Cash-Out Refinancing Example
To clarify how cash-out refinancing works, take a look at this example:
- You own a home that’s currently valued at $500,000
- You currently owe $250,000 on your mortgage
- You apply for a cash-out refinance loan for $300,000
- You pay off your original mortgage with this new loan
- You pocket the extra $50,000 in cash
- Your new mortgage has a new set of terms and a larger balance
Since cash-out refinancing adds to your outstanding balance, it will most likely increase your monthly mortgage payments. For this reason, cash-out refinancing is riskier for lenders than traditional refinancing.
In turn, you may have to meet stricter eligibility requirements to qualify. For example, many lenders will require you to have a credit score of 620 or above.
3. Cash-In Refinancing
Cash-in refinancing is the opposite of cash-out refinancing. Rather than replacing your mortgage with a larger loan, you replace it with a smaller one.
To do so, you must pay a sum of money to your lender during the refinancing process to make up for the loan amount differential. You can think of this sum of money as a second down payment.
Why would a homeowner consider cash-in refinancing? Here are a few reasons:
- It can help you build equity quickly – Many lenders require you to have a certain amount of equity in your home to even qualify for refinancing. If you don’t have that much equity yet, cash-in refinancing can help you get there.
Once you meet the equity requirement, you can enjoy all of the perks of refinancing, whether you want to get a lower interest rate or adjust your home loan term.
- It can help you eliminate private mortgage insurance (PMI) – Another perk of cash-in refinancing is that it may help you eliminate your PMI requirement. PMI is required by most lenders until you build at least 20% equity in your home. PMI can be quite costly, so getting rid of it is a worthwhile reason to refinance.
- It may improve your refinancing options – Generally, when you have more equity in your home and a lower home loan amount, you can qualify for better refinancing terms. Cash-in refinancing can help you achieve these two goals. In turn, it may help you qualify for a lower interest rate. With a smaller mortgage balance, you’ll also enjoy lower monthly payments.
4. FHA Streamline Refinance Loan
Typically, refinancing involves a lot of paperwork. During the underwriting process, your lender will verify your:
- Credit score
- Home value
- Debts and assets
You can skip this paper-work heavy process by choosing an FHA streamline refinance loan. This type of refinancing is very similar to traditional refinancing—it just has a simplified underwriting process. Most notably, streamline refinancing doesn’t require you to go through a home appraisal, an income verification, or a credit check. As a result, it can get finalized much faster.
Streamline refinancing is also easier to qualify for. If your credit score or home value has gone down since you took out your original mortgage, it won’t impact your eligibility.
Eligibility Requirements For FHA Streamline Refinancing
To be eligible for this type of refinancing, you must:
- Have an FHA-backed mortgage
- Be up to date on your mortgage payments
- Receive a “net tangible benefit” from refinancing (which just means that your new mortgage must have a notably lower interest rate or monthly payment than your existing mortgage)
If you were hoping to liquidate some cash from your equity during this refinancing process, it’s important to note that you’re only allowed to convert up to $500.
5. Reverse Mortgage Loan
If you’re over 62 and have over 50% equity in your home, you can unlock cash from this equity with the help of a reverse mortgage. This form of refinancing has no credit score requirements.
A reverse mortgage gives you cash in the form of a lump sum or a monthly income. Since it borrows this money directly from your home equity, it increases your outstanding mortgage balance over time. Fortunately, this growing balance won’t be due until you die or sell your home.
A reverse mortgage can be helpful if you need extra money to afford medical bills or daily expenses. However, it’s not a great option if you plan to move in the future or leave your home as an inheritance.
Sale-Leasebacks: A Mortgage Refinancing Alternative
There are many loans you can use to refinance your mortgage. But what if you don’t meet the eligibility criteria to qualify for the one you want?
There are always alternatives to refinancing. You can consider a loan modification vs refinance or a mortgage recast vs refinance. However, for a solution that works for you, a sale-leaseback can help with your long-term financial goals, whether those include converting your equity into cash or lowering your monthly costs. Best of all, there aren’t any strict credit score or home equity requirements.
Through a sale-leaseback option, you’ll sell your home and lease it back. When you’re ready, you can choose to repurchase your home or move and sell the house on the open market. When it sells, you receive any appreciation from the sale.
If you’re looking to refinance your mortgage, you have a few options available to you. Talk to a financial advisor about all you need to know about the process and the alternative solutions available to you.
- The Federal Reserve Board. A Consumer’s Guide to Mortgage Refinancings. https://www.federalreserve.gov/pubs/refinancings/#eligible
- The Mortgage Reports. How a cash-out refinance works: Rules, rates, and requirements. https://themortgagereports.com/68932/cash-out-refinance-guide-rules-rates-requirements#requirements
- Bankrate. PMI: How private mortgage insurance works and why it can benefit homebuyers. https://www.bankrate.com/mortgages/basics-of-private-mortgage-insurance-pmi/
- The Mortgage Reports. FHA Streamline Refinance: Rates & Requirements for 2021. https://themortgagereports.com/1604/fha-streamline-refinance-mip-refund
- HUD. Streamline Your Fha Mortgage. https://www.hud.gov/program_offices/housing/sfh/ins/streamline
- FTC. Reverse Mortgages. https://www.consumer.ftc.gov/articles/0192-reverse-mortgages