A No-Nonsense Guide to the Different Types of Mortgages (Part Four)
In part three of our “Different Types of Mortgages” series, we talked about conforming loans, jumbo loans, and super jumbo loans. Now, we’ll share some of the other types of mortgages that aren’t used for buying a residence -- from refinancing loans to home equity products.
Purchase Loans vs. Refinancing and Home Equity Options
Most people who seek out home loans are looking for a mortgage to purchase a home. However, these aren’t the only kinds of home loans on the market.
For instance, there are special mortgages designed just for refinancing your current mortgage. This means you’ll be replacing your old home loan with a new one. You might refinance to get a better interest rate or to reduce or extend the term of your loan.
Let’s start with refinancing loans.
In a traditional refinance (also called a “regular” refinance), your new lender pays off your old loan and replaces it with another mortgage. Usually, borrowers do this to improve their financial situation.
Borrowers with trouble paying their mortgage often refinance into a longer-term loan. For example, you can refinance from a 15-year fixed-rate mortgage to a 30-year fixed-rate mortgage to reduce monthly payments.
Borrowers who are facing an increasing interest rate on an adjustable rate mortgage might refinance into a fixed-rate note. Alternately, if you’re about to finish the fixed-rate period on a hybrid ARM, you may want to refinance into a fixed-rate mortgage.
Borrowers with a high fixed-rate loan (especially those who want to sell their home in a few years) often refinance into a hybrid ARM with a lower rate.
Refinancing can sometimes be long and complex, requiring just as much (or even more) paperwork as your original home loan. You’ll need detailed documentation of your income, credit score, financial history, and often an entirely new appraisal on your home.
Streamline refinancing helps speed up this process by reusing most of the paperwork and documentation from your original loan. If you go with streamline refinancing, you can expect:
- No/limited credit checks.
- No/limited income documentation.
- Use of your original home appraisal (though some lenders may require a new one).
The most common streamline refinancing products are:
FHA Streamline Refinancing
FHA streamline refinancing is for borrowers who already have an FHA mortgage. Unlike most kinds of refinancing, FHA streamline is available for borrowers with extremely small amounts of home equity. It’ll even allow borrowers who are underwater on their homes (those who owe more than their home is worth) to refinance.
In order to be approved, FHA streamline refinancing candidates need to show a “net tangible benefit.” This just means that borrowers will see a financial benefit from refinancing. This might mean reduced insurance costs, or reduced interest rates, for example. Note that cash-out refinancing is not available through this program.
VA Streamline Refinancing
VA streamline refinancing is for borrowers who already have a home loan through the VA loan program. VA streamline borrowers can roll any closing costs into their new home loan, which means they’ll usually have to pay a lot less cash upfront. Through this program, homeowners can take some cash out of their home in order to make home improvements.
USDA Streamline Refinancing
USDA streamline refinancing is for those who already have a USDA home loan. To qualify, borrowers must demonstrate a net benefit. In this case, this usually means a mortgage reduction of at least $50 per month. Right now, the only loan product available for streamline refinancing through the USDA is the USDA 30-year fixed-rate loan. Cash out isn’t available with this loan.
Though these are the only government-backed streamline refinance programs, many lenders offer their own streamline refinancing programs. If you have a conventional mortgage or a relationship with an existing bank, check with them to see if they offer streamline refinance options.
Many homeowners have had success improving their financial standing with traditional and streamlined refinancing. However, if you want to refinance while also tapping into your home equity, there’s a loan product for that. It’s called a cash-out refinance.
Most homeowners use cash-out refinances to pay for home improvements, though they can technically be used for anything. This includes medical bills, a child’s college tuition, or business startup funds, for example. The most common cash-out refinancing programs include:
FHA Cash-Out Refinancing
No matter what kind of mortgage you currently have, you can use the FHA cash-out refinance. The maximum loan-to-value (LTV) allowed for an FHA cash-out refinance is 85%, so you’ll need more than 15% home equity if you want to take significant cash out of your home.
VA Cash-Out Refinancing
VA cash-out refinancing is for VA-eligible individuals and their families. This includes current and former service members, National Guard or Reserve members, and their surviving spouses. As long as you’re eligible, you can get cash out with a VA refinance regardless of the type of original mortgage you have.
In many cases, VA cash-out refinancing allows for 100% LTV, making it the most generous cash out refinancing option on the market. VA funding fees for cash-out refinancing vary between 2.15 - 3.3%, but are waived in certain circumstances -- particularly for disabled veterans.
If you don’t qualify for any of the government-backed cash-out refinance options, check with other lenders for more options.
Home Equity Loans vs. HELOCS
A cash-out refinance isn’t the only way to tap the equity in your home. In fact, one of the most popular ways to get cash out of your house is to take out a home equity loan. Like regular mortgages, home equity loans are available with either a fixed-rate or adjustable-rate.
Home equity loans are great for financing home renovations. If you go this route, make sure you can finish the renovations you’ve started with the money you take out. The reason? It’ll be nearly impossible to get another loan on a home with unfinished repairs.
If you’re looking for a more flexible way to tap the equity in your home, a home equity line of credit (HELOC) may be your best bet. HELOCs function as revolving lines of credit, much like a credit card. This makes it possible for you to decide when and how much of your available credit you want to use.
Because of that, HELOCs may be better suited for smaller, recurring bills, like a child’s college tuition. By contrast, home equity loans may be better for paying larger, one time expenses. Unlike home equity loans, HELOCs are usually only available at an adjustable rate.