The Different Types of Refinance Loans
If you look at 100 people refinancing their home loans, no two of them will be exactly alike. They can differ in many ways, such as on the value of their homes, the type of mortgage they have, the amount they owe, and their reasons for refinancing. Knowing you want to refinance is the first step, the second is to figure out what type of loan to refinance into.
Traditional (Rate and Term)
The most common type of refinance loan is a traditional refinance. It’s often called a rate and term refinance because you can use it to change your interest rate, your loan term, or both. For instance, if interest rates are low, you could refinance an adjustable-rate mortgage, such as a 5/1 ARM, into a 30-year fixed-rate loan to lock in a lower rate for a fixed period of time. You could also refinance a 30-year loan to a 15-year loan to secure a lower rate and pay off your mortgage sooner.
A traditional refinance takes several weeks and involves a lot of paperwork. If you have an FHA loan, you can simplify the process with a streamline refinance, which requires less documentation and underwriting.
You qualify for a streamline refinance if:
- Your current mortgage is FHA-insured.
- Your payments are up to date.
- The refinance would provide a “tangible benefit,” such as a lower interest rate.
- You are not taking out more than $500 of your home equity in cash.
You can’t get a traditional refinance loan if your home is underwater – that is, its current value is less than the amount you owe. That’s why the government created the Home Affordable Refinance Program (HARP) in 2009. It allows you to refinance your home for up to 125% of its current value.
You can get a HARP refinance if:
- The home is your primary residence, second home, or investment property with no more than 4 units.
- Your current mortgage is backed by Fannie Mae or Freddie Mac.
- You got your mortgage no later than May 31, 2009.
- Your payments are up to date, with no more than one late payment in the past year.
- You refinance by December 2018, when the program is set to expire.
No Closing Cost
One problem with refinancing is the closing costs, which can add up to thousands of dollars. If you don’t have that much cash available, you can get a no closing cost refinance, in which the lender waives these costs. However, this type of loan comes with a higher interest rate, so it usually costs more in the long run. It makes most sense for a home you’re planning to sell within five years, so you won’t have to pay the higher interest for very long.
One common reason for refinancing is to tap into your home equity. A cash out refinance is like a traditional refinance, except the new mortgage loan is more than what you currently owe. The bank gives you the extra money in cash that you can put to other uses, such as paying off other debts or remodeling your home. The downside is that you’ll either have a larger monthly payment or a longer wait to pay off your new mortgage.
The opposite of a cash out refinance is a cash in refinance. With this type of loan, you pay in additional cash, like a second down payment, to keep your loan amount lower. This gives you a lower monthly payment and less time to pay off your new mortgage. It’s also a way to refinance if you’re underwater on your loan and don’t qualify for HARP.
Another way to turn your home equity into cash is with a home equity line of credit, or HELOC. This is like a cash out refinance, except instead of drawing out a fixed amount in cash, your bank gives you a line of credit that you can draw on and pay back as needed, kind of like a credit card. You can take money from your HELOC using special checks or a bank-issued card. A HELOC is typically a variable-rate loan that’s good for a fixed amount of time, such as ten years.
A final way to cash in on home equity is with a reverse mortgage. This type of loan is available only to people age 62 and up. It’s the opposite of a normal mortgage: instead of borrowing money from the bank and paying it back over time, you get regular payments from the bank that you don’t have to pay back until you die or move out of the home. A reverse mortgage can provide money for medical bills or other needs. The downside is that it eats away at the equity in your home, leaving less for your heirs.
These are only the tip of the iceberg – there are more types of loans to choose from. That’s why it’s important to understand all your options before making a decision. Talk to a mortgage professional who can give you the details about how each type of loan works and help you figure out which one fits your needs.
Ethos Lending is a new type of mortgage lender. We use technology to keep our operational costs as low as possible. From closing costs to interest rates, we have made it our mission to make the process of buying a home more affordable. Get in touch with one of our mortgage specialists to learn more.