A conventional refinance is any refinance loan that conforms to guidelines set by Fannie Mae or Freddie Mac. This type of refinance is available with as little as 3% equity with the 97% conventional refinance program.
For a conventional refinance the lender requires an appraisal and documentation regarding the borrower’s income and assets. This program is different than the FHA and VA streamline refinance programs, where neither an appraisal nor income documentation is required.
Conventional Streamline Refinance
A common question is whether a conventional streamline refinance program is available. Although technically there are no conventional streamline refinance programs, the HIRO program comes close: many HIRO loans do not require an appraisal, and most lenders request very little income documentation.
Editors Note: The HARP program ended on December 31, 2018. We are leaving this section in tact for archival purposes. Borrowers who are looking to take advantage of today’s low interest rates — but who don’t have the necessary equity — should consider the HIRO program. Learn more about HIRO here.
The Home Affordable Refinance Program (HARP) is often considered a conventional streamline program due to its easier qualification process.
Originally introduced in 2009, this program is designed to help homeowners with little or no equity in their property refinance into a lower rate.
Conventional refinance loans require equity, but many borrowers find themselves with no equity, or even negative equity (underwater). For them, refinancing would be impossible without HARP.
When the HARP program was initiated, it allowed borrowers with a Fannie Mae or Freddie Mac loan to refinance despite their lack of equity. To date, over 3 million homeowners have refinanced with HARP and many estimate there are still millions more who could benefit.
I Don’t Qualify for HARP. Are There Other Conventional Refinance Programs?
Even if you are not HARP eligible, you could qualify for a standard conventional refinance. Other conventional loan options are described below.
Rate and Term Conventional Refinance
Perhaps the most common conventional refinance loan program is the conventional rate and term refinance. “Rate and Term” simply describes the purpose of the refinance: to lower the interest rate or change the length of the loan term. Rate and Term refinances do not allow the borrower to take cash out.
Borrowers typically use this program when interest rates have fallen below the rate on their current mortgage. The lower rate reduces the borrower’s monthly payment and saves on interest over the life of the loan.
Shortening the loan term may increase monthly payments, but the loan would be paid off earlier. For example, if you’ve been paying on your 30 year loan for 3 years, you have 27 years left. By refinancing into a new 15 year loan, you shorten the time you will be making monthly payments by 12 years.
This type of refinance can also be used to change an adjustable rate mortgage to a fixed rate, ensuring that monthly payments will not rise in the future.
Conventional Cash-out Refinance
A conventional cash-out refinance is a mortgage where the borrower pulls out equity from the property in the form of cash. With the same refinance, the borrower can lower the rate or change the loan term length, if current interest rates allow. Typically, cash-out refinances are viewed as higher risk, and have higher interest rates associated with them.
Let’s look at how a cash-out refinance works. As an example, a borrower with a $200,000 loan wishes open a bigger loan of $250,000 because he needs some cash.
In this example, let’s suppose closing costs are $3,000 and the money needed to pay off the existing loan is $200,000. The net cash the borrower receives after the refinance is $47,000.
Cash out refinance loans can be opened on primary residences, second homes, and investment (rental) properties. For investment properties, more than 20% equity is typically needed.
Why Choose a Conventional Refinance?
The FHA streamline and VA streamline programs are much easier than conventional refinances because they require almost zero documentation. But to use them, the homeowner has to fit into quite narrow criteria.
A conventional refinance on the other hand can do things that streamline refinance programs can’t:
- Refinance an investment property or second home.
- Refinance any existing loan type, like sub-prime or Alt-A loans.
- Give the homeowner cash back.
Generally to qualify for this type of conventional loan, the borrower must have at least 10-20% equity in the property, have good credit, and have enough income to qualify for the new loan.
Conventional Loan Refinance Requirements
Income for a conventional refinance is verified by providing two of your most recent paycheck stubs covering 30 days, two years’ of recent W2 forms, and a two year employment history. Two years’ tax returns may be required for self-employed borrowers.
The borrowers can also expect to sign the IRS form 4506-T which allows the lender to pull tax return records directly from the IRS and compare them with the information provided by the borrower.
Bank & Investment Accounts
Proof of your assets will most likely be required. If you are required to pay any amount of money to close the loan, you will need to supply 60 days’ worth of checking, savings, or money market account statements. These are known as “liquid assets.”
You may also be required to supply non-liquid asset statements such as retirement or stock account statements. This is common when refinancing an investment property, since lenders require that you have money in reserve when getting this type of loan.
If you have enough equity, you are allowed to roll all closing costs into the new loan amount. This could eliminate out-of-pocket expenses.
Appraisal and Credit
Conventional refinance loans will require that a new appraisal be completed to determine current market value. The new value is used to establish a maximum loan amount available to the borrower. Appraisals typically cost between $350 and $550, although the cost can be much higher on high-end homes.
In addition, a new credit report will be reviewed. The required minimum credit score varies by lender, but typically a 660 score will help you qualify for most conventional refinance programs.
With the exception of HARP, conventional loans require private mortgage insurance (PMI) if the loan amount is higher than 80% of the property’s current value (Loan-To-Value of 80%+). Be sure to factor in this expense when you have less than 20% equity and considering a conventional refinance. The cost of PMI could be anywhere from $50 to well over $200, depending on loan-to-value and your credit score.
Conventional Loan Limits
For 2018, the conventional loan limit is at $647,200 for most areas. Some high-cost areas like Los Angeles, California have a loan limit up to $970,800. If you are looking at a 2, 3, or 4-unit home, the loan limits are even higher. The standard loan limit for a 4-unit home is up to $1.2 million in some areas of the country.
Eliminating FHA Mortgage Insurance with a Conventional Refinance
Another benefit of a conventional refinance loan is refinancing an FHA mortgage into a conventional one. This transaction can reduce the interest rate while removing the monthly mortgage insurance associated with FHA loans.
FHA mortgage insurance can be hundreds of dollars per month. Homeowners can eliminate that expense by refinancing into a conventional loan with no mortgage insurance. This works best when the home has gained a lot of value in the most recent few years.
In fact, converting an FHA loan into a conventional loan only works for those with enough equity in the home. For those without equity, an FHA streamline refinance should be considered first.
Questions and Answers about the Conventional Refinance Loan Program
Can I use a conventional refinance for a duplex that I have rented?
Yes, conventional refinance loans are available for single family homes or 2- to 4-unit properties for both owner occupied and rental homes.
I just refinanced my home six months ago and want to refinance again, can I use my old appraisal?
Unfortunately, no, a new loan will require a new appraisal associated with it. In addition, recent home sales in the area can reflect updated value information for your property and the lender will require recent data.
I recently listed my home for sale, or it’s currently listed. Can I refinance using a conventional loan?
Fannie Mae states that a property must not be listed at the time of loan application. It must be taken off the market prior to the date of the application for Rate and Term refinances. For cash out refinances, any home listed in the last 6 months must have a loan-to-value no more than 70%.
I’m not self-employed so why does my lender need tax returns?
Even though conventional refinance loans may not require tax returns for a wage-earner, individual lenders can have their own internal guidelines, called overlays, in addition to standard approval requirements.
Do I have to have a brand new loan application for a conventional refinance or can I use my old one if I go to my current lender?
A refinance is a brand new loan that replaces an existing one, regardless of who the new lender will be. Your lender will ask for a brand new application, signed, reflecting the current date.
If I’m refinancing, why do I need a new title insurance policy if I’m not selling the property?
You will need an updated title policy to accompany your loan. As with other documentation, changes can occur from the period between your previous loan and current conventional refinance loan. Most states allow title insurance companies to offer discounts on recently issued title policies.
I have two loans on my house; can I refinance both into one conventional loan?
Yes, you can refinance multiple loans into one, given sufficient equity in the property. When paying off a second mortgage, however, it’s typically viewed as a-cash out refinance, which incurs higher interest rates.
Can I refinance my loan and do some home improvements?
Yes, you can refinance and pull cash out for any purpose, including home improvements. You will need enough equity to qualify for a cash-out conventional loan.
I’m Ready to Apply for a Conventional Refinance
Conventional loan rates are great and it’s the perfect time to lock in your rate. Qualification standards for conventional loans have loosened up quite a bit in the past few years so chances are that you will qualify.
Photo: Unsplash/Curtis MacNewton