A conventional refinance loan is a powerful financial instrument. Lower your interest rate and payment, leverage your home equity, or get rid of mortgage insurance.
The option to refinance your mortgage is a unique benefit for homeowners. Depending on the terms of your loan and how much equity you have, refinancing can reduce your monthly payments, lower your interest rate, and provide access to cash for other financial priorities.
There are several refinance options, but the conventional refinance loan is one of the most common. You can use a conventional refinance loan whether your current mortgage is also a conventional loan or a government-backed loan (FHA, VA, USDA).
What is a conventional loan refinance?
A conventional refinance loan is one backed by the government-sponsored enterprises Fannie Mae and Freddie Mac, as opposed to those backed by government agencies. You can use a conventional refinance loan to:
- Lower your interest rate
- Reduce your monthly payments
- Eliminate mortgage insurance on USDA or FHA loans (if you have 20% equity in the home)
- Borrow cash against the equity in your home
“A conventional loan refinance essentially replaces your existing mortgage loan with a fresh mortgage loan,” says Martin Orefice, CEO of Rent To Own Labs in Orlando. “The refinance could change the interest rate, monthly payment, term, or principal on the loan, depending on the exact terms of the loan.”
Types of conventional refinance loans
There are two types of conventional refinance loans: rate-and-term refinances and cash-out refinances.
“A rate-and-term refinance simply exchanges your current loan for one that has better terms and hopefully a lower interest rate,” says Carter Seuthe, CEO of Credit Summit in Austin, Texas.
Lowering your interest rate
The rate in rate-and-term refers to the interest rate on the loan.
Many homeowners chose to refinance in 2020 and 2021 when interest rates dropped to unprecedented lows. Refinancing can still be a good option, even as rates are rising. Rates are still quite low by historical standards, and homeowners may save tens of thousands of dollars by refinancing.
But refinancing can be a smart move regardless of what’s happening in the market. If your credit, income, or debt-to-income ratio (DTI)* have improved significantly since you bought the home, you may qualify for a better interest rate now than when you first purchased.
Changing your repayment term
A rate-and-term refinance also allows you to change the term, or repayment period, of your loan.
For instance, you can refinance a 15-year mortgage to a 30-year loan, which can lower your monthly payments because they’re spread over a longer timeline. That can be a big help if you’re struggling to make your payments due to a drop in income or other expenses that have come up.
On the other hand, you can refinance a 30-year mortgage to a 15-year loan if you want to save money on interest by paying the loan off earlier.
Eliminating mortgage insurance
If you purchased your home with a USDA or FHA mortgage, you are likely paying an annual mortgage insurance premium for the life of the loan.
FHA loans with less than 10% down have an upfront and annual mortgage insurance premium (MIP) that lasts for the life of the loan. Zero-down USDA** loans also have upfront and annual mortgage insurance fees for the life of the loan.
Once you have 20% equity, you can refinance to a conventional loan to eliminate the mortgage insurance requirement.
Conventional loans require private mortgage insurance (PMI) for loans with less than 20% equity in the home. If you have a government-backed loan and now have 20% equity or more in the home, you can refinance to stop paying mortgage insurance, thereby reducing your monthly payment.
Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage
If you took out an adjustable-rate mortgage, also known as an ARM, you can refinance to a fixed-rate loan to stabilize your mortgage payment. ARMs are attractive because they typically have a low, fixed interest rate for the first few years of a loan, after which the rate becomes variable.
The variable rate adjusts a certain amount for a set period of years, and it can go higher or lower depending on the market. In the current interest rate environment, in which rates are rising, homeowners may want to lock in a low rate to ensure that their payments stay affordable.
“A cash-out refinance creates a new mortgage with a balance higher than what you currently owe and gives you the excess amount in cash,” Seuthe says.
Let’s say you’ve paid off 80% of your mortgage, and you want to renovate your home. Perhaps it’s time to redo the kitchen, or add another bedroom for a home office or studio. You can use a cash-out refinance to borrow against that equity.
The new loan will include your remaining balance on the current mortgage plus the amount you’ve taken out in cash. It effectively pays off your first mortgage, and you receive the difference as a lump sum after the loan closes.
“Often, a cash-out is pursued when a mortgage has been largely paid off and the borrower with plenty of built-up equity wants to get a new loan, or the home’s value has increased significantly since the original mortgage,” Orefice says.
"Often, a cash-out is pursued when a mortgage has been largely paid off and the borrower with plenty of built-up equity wants to get a new loan, or the home’s value has increased significantly since the original mortgage."
Martin Orefice, CEO of Rent To Own Labs
You can use the proceeds from a cash-out refinance however you choose, including:
- Consolidate high-interest debt
- Renovate your home
- Pay for education expenses
- Down payment on another property
However, it’s important to note that a cash-out refinance increases the amount you owe on your home. If your current mortgage balance is $200,000 and you take out of a cash-out refinance for $250,000, you’ve reset the clock on paying off your house.
Your monthly mortgage payments may be higher than what they are now as well, so make sure you’re comfortable with those amounts.
Be sure to consider whether your income is likely to change within the next several years, and how that might impact affordability. If you plan to retire or you plan to take time off to start a family, for instance, that could make it more difficult to manage the higher payments.
How much money can you get with a cash-out refinance?
There are limits to how much equity you can tap into with a conventional refinance loan. It’s not quite as lenient as a VA cash-out refinance loans, which are available to eligible members of the military community and allow you to borrow against 100%*** of the home’s value.
With a conventional cash-out refinance loan on a primary residence with one unit (meaning the single-family home you live in most of the year), you can borrow up to 80% of the home’s value.
Let’s say your home is worth $300,000, and you owe $200,000 on your mortgage. Here’s how your cash-out refinance might work:
Value of the home$300,000Maximum loan amount (80% of home value)$240,000Remaining balance from original mortgage$200,000Cash-out amount$40,000 less closing costs
The cash-out refinance loan for $240,000 would pay off your existing mortgage of $200,000, and you’d receive the $40,000 (after closing costs and fees) in cash.
Conventional refinance loan: Who qualifies?
To qualify for a conventional refinance loan, you’ll need to meet the following criteria:
- Credit score: 620 or higher
- Debt-to-income ratio: of 50% or less. For a conventional loan, lenders may require a DTI of 45% or less
- Minimum loan seasoning: “Seasoning” refers to how long you’ve had your current home and/or loan. For a cash-out refinance, you need to have closed on the current loan at least six months ago, unless you paid for the home in cash. For rate-and-term refinances, you still may have a waiting period depending on the lender. But if you inherited the home, there is no seasoning requirement for refinancing
- Sufficient equity: There’s no set amount of equity you need to qualify for a cash-out refinance loan, though 30-35% is a good rule of thumb. That allows you to take out 10-15% before you reach the maximum loan-to-value of 80%. Of course, the more equity you have, the more money you’ll be able to take out against the house. For no-cash refis, you may be able to get a refinance for up to 97% of the home’s current value.
- Sufficient benefit to the homeowner: If you are taking out a rate-and-term conventional refinance loan, your lender will verify that the new loan provides enough benefit to move forward. If you want to reduce your interest rate, they need to ensure that the new rate is low enough to make a real difference in what you’ll owe over the life of the loan. Likewise with reducing your monthly payments. Conventional refinance loans have closing costs and fees, just as purchase loans do. Your lender has to justify approving a new loan on the grounds that it will benefit you as the homeowner
The process of applying for a conventional loan refinance is similar to what was involved when you first applied for a home loan.
“You will have to apply in-person or online with a mortgage lender, undergo a credit check, get an appraisal of your property unless one has been done recently, and go through an underwriting process,” Orefice says.
Conventional loan refinance FAQs
Can you refinance a conventional loan? Yes. You can refinance your existing conventional loan to another conventional loan or to another type of loan (FHA, VA, or USDA).
You can opt for a rate-and-term refinance – in which you get a lower interest rate or a shorter or longer repayment term – or a cash-out refinance in which you borrow against the equity in your house.
What is needed for a conventional refinance loan? To qualify for a conventional refinance loan, you will need a credit score of 620 or higher and a debt-to-income ratio of 45% or less. Depending on your loan program, you may need to have closed on the house at least six months prior to refinancing. If you plan to do a cash-out refinance, your lender or loan program may have a minimum equity requirement.
How much equity do I need to refinance to a conventional loan? you are refinancing to a conventional loan from a USDA or FHA loan to remove mortgage insurance, you will need at least 20% equity. If you are refinancing for a better interest rate or term, or you do not plan to take out cash against your equity, the equity requirement may be lower.
A way to save
A conventional refinance loan is a great tool for homeowners, whether you need more room in your monthly budget or you need cash for new financial priorities. If you’re wondering how a refinance loan may help you, talk to a lender about which refinance programs you qualify for and which are best for your goals.
*Debt-to-income (DTI) ratio is monthly debt/expenses divided by gross monthly income. **USDA Guaranteed Rural Housing loans subject to USDA-specific requirements and applicable state income and property limits. Fairway is not affiliated with any government agencies. These materials are not from USDA or RD and were not approved by USDA or RD or any other government agency.