Refinancing a mortgage to lower the current rate, term or monthly payment is the primary objective of a rate and term refi. The ultimate goal of replacing a home owner’s current mortgage with a better one by refinancing is only achieved by this process. A rate and term refinance are designed to lower the interest rate or the term of the existing loan, or both.
A homeowner refinancing their existing mortgage with a lower rate but at the same term achieves a lower monthly payment. Refinancing at a shorter term may sometimes lead to a higher payment. The advantage of such is equity building. Reducing the term of the loan pays off the mortgage in a short period of time, thereby, building equity faster.
There are different loan types available for rate and term refinance transactions:
- Conventional Refi – conventional refinancing is the process of refinancing an existing mortgage loan with a conventional loan, lowering the rate, term or monthly payment. It can either be a conventional loan to conventional loan or FHA loan to a conventional loan. Typically, homeowners avail of the rate and term refinance to convert an adjustable mortgage rate (ARM) loan to a fixed loan.
FHA to conventional refi is suitable for homeowners who want to get rid of their Mortgage Insurance Premium (MIP) on their FHA loan.
- FHA Refi – There are different types of FHA refinance loans. The primary objective in doing FHA refinance is to lower the rate and monthly payment.
- Conventional to FHA – usually done because the loan-to-value exceeds the maximum allowed by a conventional loan. Borrowers can get up to 97.75% loan-to-value on FHA refinance loans. Also, use to convert an Adjustable Rate Mortgage (ARM) loan to a fixed rate mortgage.
- Non-Streamline FHA to FHA refinance – current FHA loans can be refinanced to another FHA loan to lower the rate and monthly payment. Also referred to as “regular FHA refi” transaction, the homeowner can lower the rate, term or monthly payment.
- Streamline FHA refi – the new FHA loan has to meet the 5% monthly payment reduction rule if current loan is not an adjustable rate mortgage (ARM). The new FHA loan has to meet the net tangible benefit rule. According to HUD 4155.1 Chapter 6 Section C, “Net tangible benefit” is defined as:
- A 5% reduction to the P&I of the mortgage payment plus the annual MIP, or
- Refinancing from an Adjustable Rate Mortgage (ARM) to a fixed-rate mortgage.
There are several types of FHA Streamline Refinance loans:
- Full Credit, No Appraisal Streamline Refi – credit is used to qualify for the loan but no appraisal is required. It doesn’t matter how much the value of the subject property is, file is underwritten based on original value and existing loan;
- No Credit Qualifying, No Appraisal Streamline Refi – credit report is not pulled, only mortgage history is used to qualify. No appraisal is required either. The original loan is used as a value and existing pay-off determines loan amount.
- No Credit Qualifying, Full Appraisal Streamline Refi – No credit report is pulled, only mortgage history is used to qualify for the loan. An appraisal report is required to determine the value of the subject property.
A reduction in the term of the mortgage, in and of itself, is NOT a net tangible benefit in FHA Streamline Refinance Loan. However, a term reduction in conjunction with an interest rate reduction MAY result in the net tangible benefit rule.
Homeowners must be current on the mortgage being refinanced for the month due prior to the month in which they close the refinancing and for the month in which they close. An evidence of prior ownership of the house is required to determine any undisclosed identity-of-interest transactions.
When using a Streamline Refinance option, whether it be No Credit, No Appraisal or any combination thereof, the homeowner cannot carry or roll in the closing costs of the loan to the new mortgage. The borrower must pay all closing costs at the time of settlement. Only the Non-streamline or “regular” FHA refinance loan program allows closing costs to be rolled into the new loan.
- VA Refi – The Veterans Administration Home Loan offers a streamline refinance program that helps lower current interest rate by refinancing an existing VA mortgage.
- IRRRL – Interest Rate Reduction Refinance Loan. This either lowers the current interest rate or converts an Adjustable Rate Mortgage (ARM) to a fixed-rate mortgage.
An IRRRL must be a VA to VA refinance and it will reuse the entitlement that was originally used by the veteran or their eligible spouse. A new Certificate of Eligibility (COE) is not required. Occupancy requirement is also different from other VA loans. The borrower only needs to certify that he previously occupied the home.
An IRRRL can roll in all the closing costs into the new loan. Although VA does not set a cap on how much a borrower can use to refinance, VA will limit their liability or exposure. This, in turn, affects the amount of money allowed to refinance. The so-called “loan limits” vary by the county since the value of a particular house depends in part on where it is located.
The VA Funding Fee is generally paid by the veterans who are using the VA Home Loan Guarantee. The funding fee is a percentage of the loan amount. However, the VA Funding Fee is waived for either of the following reasons:
- Veteran is receiving disability benefits or compensation for a service-related/connected disability;
- Veteran who would be entitled to receive compensation for a service-related disability if you did not receive retirement or active duty pay;
- Surviving spouse of a veteran who died in service or from a service-connected disability.
IRRRL can be used as an opportunity to reduce the term of the existing mortgage loan from 30 years to 15 years. While this option saves money in interest over the life of the loan and builds equity faster, this option should be exercised with caution. Typically, a reduction in term equates to a higher monthly payment.
- USDA Refi – An existing USDA loan can refinance to a USDA loan either as USDA Guaranteed or USDA Direct Mortgage. The primary purpose of refinancing from a USDA to a USDA loan is to lower the interest rate on the current mortgage, therefore, lowering the monthly payment. Refinancing is only available at a fixed rate.
Homeowners who currently do not have an existing USDA loan cannot refinance to a USDA loan. They can, however, refinance to an FHA or conventional loan, perhaps, a VA loan.
There is no maximum loan amount allowed on USDA refinance loan. The borrower’s debt-to-income (DTI) ratio dictates how much they can afford. Currently set at 29/41, an exception is only made with compensating factors.
The basic requirements for USDA Refinance are:
- Existing mortgage has to be current and not delinquent;
- Existing mortgage has to be USDA mortgage already;
- Proposed P&I monthly payment has to be lower than current USDA mortgage;
- No cash out must be taken out using the USDA refinance program.
USDA Refinance Non-streamline requires a full appraisal of the property. All closing costs and guarantee fee can be included in the loan amount but the appraised value can only exceed by as much as the guarantee fee itself.
A home equity refinance loan, also known as “Cash-Out Refi” is a different type of refinancing transaction. In Texas, it is commonly referred to as either a “Texas Cash Out” or an “Agency Cash Out”.
For additional information about refinancing loans, contact our Home Loan Specialists at (832) 562-8319.