Conventional refinancing may sound intimidating. But once you understand the process, you’ll find that it makes perfect sense and can dramatically improve your personal finances.
What is a Conventional Refinance?
A conventional or conforming refinance is a replacement of your existing home loan with a new conventional loan that is not backed by any government entity.
If that still sounds confusing, consider each word individually. A “refinance” is when you replace your current home loan with a new loan because the new loan offers better terms for your current situation. The “conventional” part of conventional refinancing just means that your new loan won’t be backed by the government in the way that an FHA loan, VA loan, or USDA loan would.
You can use a conventional refinance for any residential property you own, whether it’s your primary residence, second home or investment property.
What is the Purpose of a Conventional Refinance?
There are several reasons why a conventional mortgage refinance might meet your needs better than your current loan:
Lower Interest Rates
With a conventional refinance you can get a lower interest rate if current interest rates are lower than when you originated your current loan. You might also be able to get a lower interest rate if you have substantially improved your credit score since originating your current loan. Either way, a lower interest rate translates into lower monthly payments for you over the remaining term of the loan.
Remove Private Mortgage Insurance (PMI)
Removing private mortgage insurance (PMI) is another reason you may be interested in a conventional refinance. If your current loan requires PMI payments because your down payment was too low, you can use a conventional refinance to remove PMI once you have enough equity in your property (typically 20% equity).
With FHA loans, the mortgage insurance stays on for the life of the loan. If you currently have an FHA loan with FHA mortgage insurance, you may be able to cancel said insurance through a conventional refi loan. This would also reduce your monthly mortgage payments.
Change Loan Terms
Switching to a longer loan term could mean lower monthly payments over the lifetime of your loan. If you divide the remaining balance on your loan by a new 30-year loan term, your monthly payments will probably be lower than what you’re currently paying. Just know that you would likely pay more in interest over the long term.
Turn Home Equity into Cash
One of the most attractive conventional refinance perks is the ability to extract cash from your home equity. To do this, you would need to explore a cash-out refinance.
Refinance Out of Any Loan Type
Several government-backed mortgages, like the VA loan, require you to have a VA loan in order to use that refinance product. A conventional mortgage allows you to refinance out of any loan type, meaning you can refinance your FHA loan to a conventional, USDA loan to a conventional loan, and so on.
Types of Conventional Refinances
There are three general types of conventional refinances:
Rate-and-term. In a rate-and-term refinance, you simply change the interest rate and/or term of your loan. You don’t take any cash out of your home’s equity, and you don’t put an additional large sum into your home.
Cash-out. With a cash-out mortgage, you turn your home’s equity into cash in your pocket. If you have equity built up in your home and you need cash to pay off debt, cover unexpected medical expenses, renovate your home or launch a business, a cash-out refi can get you the money you need.
Cash-in. With a cash-in mortgage, you’re injecting a large lump sum into your home (almost like making a second down payment). You might choose a cash-in refi if you need to boost your home equity to remove PMI, for example.
The refinance loan option that's best for you depends on your current financial situation and financial goals. Refinance rates may vary between the three types. Get in touch with our team at Paddio to learn which option may be right for you.
Conventional Refinance Requirements
To get a conventional refinance, there are a few basic requirements.
First, you need good enough credit to qualify for a conventional loan. Lenders typically look for a credit score of at least 620. This is higher than the credit score required for government-backed loans, but conventional loans usually come with a better interest rate that justifies the higher credit score requirement.
Then you need to have enough equity in the home to qualify for a conventional refinance. The required equity depends on the type of refinance you’re doing:
You typically need at least 3% equity to do any conventional refinance.
To do a cash-out refinance, you generally need at least 20% equity.
If you’re refinancing from a jumbo loan to a conventional loan, you’ll need equity somewhere between 10.1% and 25%, depending on the loan amount.
Finally, you need to demonstrate that you have enough income to cover your new mortgage payment. Your lender will look at your debt-to-income ratio to see how much of your income is allocated to paying down debts like student loans, auto loans, credit cards, and your new mortgage. For a conventional refinance, lenders like to see a debt-to-income ratio of 50% or less. This is more strict than government-backed mortgage loans, but the lower interest rate of a conventional refinance justifies the stringent requirements.
What Are the Costs to Refinance?
You’ll typically pay somewhere between 2% and 6% of the loan amount to refinance a conventional loan. This covers loan origination fees charged by the lender.
The good news is that you typically don’t have to pay this amount upfront; your lender can usually roll these costs into your loan so you pay them over the term of your new loan as part of your mortgage payment. And if you’re saving money by getting a lower interest rate or removing mortgage insurance, the cost to refinance can be money well spent.
Pros and Cons of Refinancing
As with most financial decisions, there are pros and cons associated with refinancing.
Pros of refinancing
With a lower interest rate, you can reduce your monthly mortgage payment and reduce the amount you pay over the long term.
If you can eliminate PMI or FHA mortgage insurance, you can reduce your monthly payment.
Refinancing to a shorter-term can reduce your total interest expense over the term of the loan.
Refinancing to a longer-term can reduce your monthly payments.
Using a cash-out refinance allows you to use your home equity to put cash in your pocket.
Using a cash-in refinance can lower your total interest expense and potentially allow you to remove PMI to reduce your monthly payment.
Cons of refinancing
Refinancing can be a hassle since you need to provide the necessary paperwork to qualify for the loan. New loan documentation also needs to be signed.
Refinancing costs money. Even though you can probably roll the expense into your new loan, you will end up paying the fees.
The refinance process can take several weeks.
Is Refinancing Right for You?
Conventional refinancing is flexible enough to be a solid mortgage solution for many homeowners. It might be the right fit for you if you’re looking to lower your monthly payment, reduce your interest expense, or get cash out of your home’s equity.
If your current mortgage loan isn’t working for you, get in touch with one of our loan specialists at Paddio today.