Refinancing your mortgage: when it makes sense, and when it doesn't

What are the types of refinance?

Every refinance pays off your current mortgage with a new one. What changes is why you're doing it, and that decides which rules apply. There are three main types.

• Rate-and-term refinance. You change the interest rate, the loan length (term), or the loan type. Examples: FHA to conventional, or an adjustable rate to a fixed rate. Fannie Mae calls this a limited cash-out refinance. It caps the cash back to you at 1% of the new loan amount or $2,000, whichever is greater.
• Cash-out refinance. The new loan is bigger than what you owe. You get the difference as cash, or use it to pay off other debts.
• Streamline refinance. FHA and VA each have a refinance with less paperwork for people who already have that type of loan. These are the FHA Streamline and the VA Interest Rate Reduction Refinance Loan (IRRRL).

Before any of that, I want to know your goal. The goal picks the tool.

Is refinancing worth it? Start with the break-even point

A refinance costs money. That includes lender fees, often an appraisal, title and closing costs, recording fees, and prepaid items like taxes and insurance for a new escrow account. The key question is how long your savings take to pay back those costs. That's your break-even point.

Break-even is just the start. I also compare:

• Total interest over the time you'll keep the loan, not just the monthly payment.
• Restarting the clock. Say you're seven years into a 30-year loan and refinance into a new 30-year loan. You've added seven years of payments. A lower payment can still mean more total interest.
• Costs added into the loan. Rolling closing costs into the loan keeps cash in your pocket. But it raises the balance you pay interest on.

Run your own numbers in the refinance calculator, then let's look at them together.

What is an FHA Streamline or VA IRRRL?

FHA Streamline Refinance

This is for people who already have an FHA loan. Here are the key rules under HUD's handbook, as summarized by the FDIC's affordable mortgage lending guide:

• Waiting period (seasoning): at least 210 days must have passed since your current FHA loan closed. You must have made at least six payments. And six months must have passed since your first payment was due.
• Net tangible benefit: the refinance must help you by lowering your rate, shortening your term, or both.
• No cash out.
• Appraisal: a new appraisal is not required.
• Credit: it can be done with income and credit checked (credit qualifying) or without (non-credit qualifying). Credit qualifying is required when someone is being taken off the loan.

VA Interest Rate Reduction Refinance Loan (IRRRL)

This is for people who already have a VA-backed loan. You must certify that you live in the home now or used to live there. Federal law (38 U.S.C. 3709) adds specific protections:

• Waiting period (seasoning): six monthly payments in a row on your current loan, or 210 days after its first payment due date, whichever is later.
• Rate drop: going from fixed to fixed, the new rate must be at least 0.50 percentage points (50 basis points) lower. Going from fixed to adjustable, it must be at least 2.00 percentage points (200 basis points) lower.
• Recoupment: fees and closing costs must be scheduled to be paid back through savings within 36 months of the loan date.

A VA funding fee may apply unless you're exempt. It can be added into the loan.

How does a cash-out refinance work?

Cash-out rules depend on the loan type. For conventional loans sold to Fannie Mae, Selling Guide B2-1.3-03 sets the main rules:

• Six months on title. At least one borrower must have been on the home's title for at least six months before the new loan funds. Exceptions include inherited or legally awarded property, the delayed financing exception, and certain borrower-controlled LLCs and revocable trusts.
• Twelve-month first mortgage seasoning. If the cash-out pays off a current first mortgage, that mortgage must be at least 12 months old, measured note date to note date.
• Lower loan-to-value limits. Loan-to-value means your loan amount compared to the home's value. The maximum is lower for cash-out than for purchases or rate-and-term refinances, and cash-out pricing applies.

Bought your home with cash? Delayed financing

If you paid cash for the home in the past six months, Fannie Mae's delayed financing exception may let you take that cash back out without waiting for the six-month title rule. Here are the conditions:

• The purchase must have been an arm's-length transaction (between unrelated parties).
• The settlement statement must show no mortgage was used.
• Where your purchase money came from must be documented.
• The new loan can't be more than your documented investment plus financed closing costs, prepaid fees and points, subject to loan-to-value limits.
• Gift money used for the purchase can't be paid back from the new loan.

FHA and VA have their own cash-out programs with their own rules. I'll walk you through whichever applies to you.

Can you refinance to get rid of mortgage insurance?

Yes. This is one of the best reasons to refinance, and people often miss it.

• Conventional PMI: you may not need to refinance at all. Under the Homeowners Protection Act, you can ask to cancel PMI when your balance reaches 80% of the original value. It ends automatically at 78%, if you meet the requirements. Some servicers also consider a new appraised value, under their own rules.
• FHA mortgage insurance premium (MIP): for FHA case numbers assigned on or after June 3, 2013, MIP lasts 11 years if your starting loan-to-value was 90% or less. It lasts for the life of the loan if it was above 90%. You can't cancel it early by asking. Refinancing into a conventional loan, once you have enough equity, is the usual way to end it.

Even if the new rate isn't lower, dropping mortgage insurance can lower your total payment.

When should you refinance? Good reasons

• Lower your rate enough to hit your break-even well within the time you'll keep the loan.
• Shorten your loan to pay the home off sooner and pay less total interest.
• Move from adjustable to fixed before a rate change you can't comfortably handle.
• Remove FHA mortgage insurance by moving to conventional.
• Take someone off the loan after a divorce or separation.
• Use your equity for a renovation, a big expense, or to buy out a co-owner.
• Pay off high-interest debt, carefully and with a plan (more on that below).

Should you use a cash-out refinance to pay off debt?

Rolling credit cards, a car loan or personal loans into a cash-out refinance can lower what you pay each month. But you're changing the kind of debt it is.

• Short-term debt stretched over a long time. A five-year car loan spread over 30 years can cost more in total interest, even at a lower rate.
• The cards can fill back up. If spending habits don't change, you can end up with the new mortgage and new card balances.
• Closing costs. You're paying to refinance your whole mortgage, not just the debt.

Sometimes paying off debt this way is the right move. Just do it with a plan for the paid-off accounts.

How do you qualify for a refinance?

1. Equity. Your home's current value, usually backed by an appraisal, compared to what you owe and what you want to borrow.
2. Credit. Scores and history affect whether you qualify and your pricing. Cash-out usually has stricter standards.
3. Income and DTI (debt-to-income ratio: how much of your monthly income goes to debt payments). Most rate-and-term and cash-out loans need full paperwork. Some streamlines need less.
4. Payment history. Recent late mortgage payments can affect whether you qualify, especially for streamline programs.
5. Seasoning. How long you've owned the home and had your current loan.
6. Occupancy. Refinances on the home you live in, a second home and a rental property have different rules and pricing.

What documents do I need to refinance?

• Government-issued photo ID and permission to pull credit
• Your current mortgage statement (and statements for any second mortgage or HELOC)
• Homeowners (and flood, if it applies) insurance declarations page
• Income paperwork: pay stubs and W-2s, or tax returns if self-employed
• Recent bank statements if you'll bring money to closing or need reserves (savings left after closing)
• For delayed financing: the purchase settlement statement and proof of where the money came from

How much equity do you need to refinance? Plus costs and your right to cancel

On a refinance, equity does the job a down payment does on a purchase. More equity generally means more options and better pricing. How much cash you can take out is limited by the program's loan-to-value caps.

What is the three-day right to cancel?

When you refinance the home you live in, federal Regulation Z (12 CFR 1026.23) generally gives you the right to rescind, or cancel, the loan. You have until midnight of the third business day after the latest of these: closing, getting the rescission notice, or getting all the required disclosures. Loan money doesn't go out until that period ends. So plan for it if you're paying off debts on a deadline.

There are exceptions. Purchase loans don't have this right. Neither do refinances of second homes or rental properties. If you refinance with the same lender, the right applies only to any new money beyond your current balance and the refinance costs.

In Georgia, a closing attorney conducts your refinance closing, and the attorney's firm handles the title work and the entire closing.

What are the benefits of refinancing?

• A lower rate, payment or total interest when the math supports it
• Paying off your home faster with a shorter loan
• A way off FHA mortgage insurance
• Access to your equity in one fixed-rate loan
• Streamlines with less paperwork for FHA and VA borrowers

What are the downsides of refinancing?

• Closing costs are real. Every refinance has to earn back what it costs.
• Restarting the clock can raise your total interest even when the payment drops.
• Cash-out replaces your whole rate. If your current rate is low, a cash-out refinance gives up that rate on your entire balance, not just the new money. A HELOC or home equity loan may be the better tool.
• Waiting periods and appraisals can delay or change your options.

Cash-out refinance vs. HELOC vs. home equity loan: which is better?

I go deeper on this in HELOC vs. cash-out refinance.

How I decide whether to recommend a refinance

1. Your goal first. Payment, loan length, mortgage insurance, equity or a restructure.
2. Every cost, up front. Lender fees, appraisal, title and closing, and prepaids.
3. Break-even and total cost over the time you realistically expect to keep the loan.
4. Every option side by side. Rate-and-term, cash-out, streamline, HELOC, or simply waiting.
5. A straight answer. If the numbers don't work, I'll tell you not to refinance yet.

Common questions about refinancing & cash-out

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