The Basics of Refinancing: Rate and Term, Cash-Out, and Cash-in

The Basics of Refinancing

“Financing”, in the mortgage world, refers to the act of borrowing money from the bank to pay for a home. Later, the homeowner can replace his mortgage with another mortgage that might perhaps have a lower mortgage rate. He then has to go through the entire financing process again. This repetition is called “refinancing”. Thus, when you take out a new mortgage to pay off an earlier one, it is called refinancing.

The Re-Verification Process

Refinancing basically establishes a new loan under completely new terms. As a result, applicants for refinancing need to undergo verification once again through the same process of approval that they undertook for the first loan. A refinanced mortgage is nothing but a completely new debt, and all the rules are followed accordingly.

An applicant for refinancing is evaluated against three basic criteria, which are the same ones used for the initial home purchase loan:

  • Employment and Income History
  • Credit Payment and Credit Score History
  • Cash Reserves and Retirement Assets

The home which is being refinanced will also be appraised in order to calculate its current value in the market.

Finally, all the above traits will be compared with the prevailing mortgage standards. If all the guidelines are met successfully, the refinancing gains approval and the old loan is replaced.

Types of Mortgage Refinance

There are three types of mortgage refinances. These are rate-and-term refinance, cash-out refinance and cash-in refinance. Individual circumstances will dictate the ideal mortgage refinance for the homeowner.

Rate-and-Term Refinance: In this kind of refinance, there are only things that differ from the original loan. These are either the rate of the mortgage, the term of the loan, or both. Loan term refers to the duration of the mortgage.

The homeowner may thus refinance from a 40 year fixed rate mortgage into a 20 year fixed rate mortgage. He might also refinance from a 40 year fixed rate mortgage at 8 percent mortgage rate to a 40 year fixed rate mortgage at 4 percent mortgage rate.

At closing, the homeowner cannot take away more than $2,000 in liquid money. The loan balance may include escrow reserves and closing costs.

Cash-Out Refinance: Similar to the rate-and-term refinance, in a cash-out refinance, the new loan might have a shorter loan term or lower rate of mortgage compared to the original loan. However, what sets apart a cash-out refinance is that the original mortgage’s loan balance is increased so that it can account for cash at closing that is more than $2,000, to combine existing mortgages or for consolidation of debt.

Since cash-out mortgages put the bank under more risk than a rate-and-term refinance, they have stricter standards of approval. These loans might be limited to lower loan sizes than a rate-and-term refinance or they might even require the applicant to have higher credit scores.

Cash-In Refinance

With this kind of refinance, the homeowner pays down the loan balance by bringing cash to closing. As a result, the refinanced loan might have either shorter loan term, a lower mortgage rate or even both at the same time. While there are various reasons why homeowners decide to go for a cash-in refinance, the most common motive is to gain access to lower rates of mortgage. These are available only at low loan-to-values. They also do it to eliminate mortgage insurance payments for mortgages that are over 80% loan-to-value. Not only do mortgages below 80% LTV receive better mortgage rates, they also do not pay PMI.

Special Refinance Loan Programs

When it concerns refinancing, there are four other mortgage programs in which the approval process differs. These programs are known as “streamline” programs because their requirements are extremely simplified.

With these refinances, the lender often does away with huge portions of the usual approval process, which might include credit score minimums, appraisals and income verification.

The four programs include:

  • Home Affordable Refinance Program or HARP for homeowners that have a Freddie Mac or Fannie Mae mortgage.
  • FHA Streamline Refinance for homeowners who have a FHA mortgage.
  • USDA Streamline Refinance for homeowners who have a USDA mortgage.
  • VA Interest Rate Reduction Refinancing Loan or IRRRL for homeowners who have a VA mortgage.

These streamline refinances are available with any lender and the rates of mortgage are the same as those offered with conventional refinances.

Would you like to learn more about mortgage plans and how to get approved? click here.

About Ric Dizon

Ric Dizon is a mortgage consultant (NMLS 230093) with iMortgage, a premier mortgage banker in Long Beach, California. He's in love with four things in life...being a dad, his Ku'uipo Pamela, Hawaii and finding you the right home loan. More about Ric. Connect with Ric on Facebook, Google+, Pinterest, Twitter and check out his Instagram photos.