How Does Refinancing Work?
A refinanced mortgage represents a brand new debt and must be underwritten accordingly. As with a home purchase, there are three basic areas where a borrower is evaluated:
- Credit Score
- Income and Employment History
- Appraisal (loan to value)
Types of Mortgage Refinance
Mortgage refinances come in three varieties — rate-and-term, cash-out, and cash-in. The refinance type that’s best for you will depend on your individual circumstance.
In a rate-and-term refinance, the only terms of the new loan which differ from the original one are the mortgage rate, loan term, or both. For example, in a rate-and-term refinance, a homeowner may refinance from a 30-year fixed rate mortgage into a 15-year fixed rate mortgage; or, may refinance from a 30-year fixed rate mortgage at 5 percent mortgage rate to a new, 30-year fixed rate mortgage at 4 percent. With a rate-and-term refinance, a refinancing homeowner may not walk away from closing with more than $2,000 in cash.
In a cash-out refinance, the new mortgage may also have a lower mortgage rate or shorter term as compared to the original home loan. However, the defining characteristic of a cash-out mortgage is that the loan amount of the new mortgage is increased to account for cash back at closing of more than $2,000 (or a second lien is paid off and consolidated into the new first mortgage). The money can be used for debt consolidation, home improvement, college education etc.
Cash-out mortgages represent more risk than a rate-and-term refinance and, therefore, carry more strict underwriting guidelines. Cash-out refinances will have limitations on loan to value and often require higher credit scores.
With a cash-in refinance, a refinancing homeowner brings cash to closing in order to pay down the loan balance. The refinanced mortgage may also have a lower mortgage rate, or a shorter loan term, or both. There are several reasons why homeowners opt to do a cash-in mortgage, but the most common reason is to get access to lower mortgage rates which are only available at lower loan-to-values. Cash may also be used to buy the loan down to the conventional loan limit (from a more expensive Jumbo loan), or to remove private mortgage insurance (PMI).