Homeowners who own their home free and clear are still able to refinance their home. Any loan that isn't considered a purchase is classified as a refinance, even if there isn't a loan to pay off. The mortgage industry has not created specific terminology distinguishing a nonpurchase loan for a home that is free and clear. Since rate-and-term refinances require that the borrower receive the lesser of 2 percent or $2,000 back at close, all mortgage loans over $2,000 do not qualify as rate-and-term refinances. This is the general rule; however, some large banks may offer special programs for borrowers with free and clear homes.
Conventional Cash-Out Refinances
Fannie Mae and Freddie Mac, the nation's two largest mortgage investors, require that mortgages on free and clear homes qualify under the cash-out refinance rules. Often the maximum loan-to-value (LTV) is lower than purchase loans or rate-and-term refinance loans. The interest rate may be higher depending on what loan-to-value your new loan requires. If you keep your loan's LTV under 50 percent, the interest rate difference should be minimal. If your loan's LTV exceeds 80 percent, mortgage insurance may be required.
FHA Cash-Out Refinance
The Federal Housing Authority (FHA) offers cash-out refinances for homeowners with free and clear homes. FHA limits the LTV to 85 percent. FHA also requires an upfront mortgage insurance premium (UFMIP) and monthly mortgage insurance premium (MIP) on every loan. The home must be occupied by the borrower as the primary residence and be a one- to four-unit home. If you purchased the home within one year of the application, the lesser of the appraised value and the original purchase price of the home will be used when calculating the LTV. If you inherited the home, you may use the appraised value when determining LTV.
Home Equity Lines of Credit (HELOC)
Home Equity Lines of Credit (HELOC) provide a secured line of credit against your home. Normally these occupy a second mortgage position on the home's title. However, you do not need a first mortgage to obtain one. Most HELOCs are adjustable mortgages, so the payment varies depending on the current loan amount and the current interest rate. Like a credit card, you only pay interest on the amount of the line of credit you are using, and you can pay the line of credit down or off and reuse the loan repeatedly until the draw period expires. If you do not want a full new first mortgage, but would like to access your home's equity if needed, this is an option worth considering.
FHA offers the Home Equity Conversion Mortgage (HECM) for seniors who hold substantial equity in their homes. FHA insures these loans and they are only available through FHA-approved lenders. A HECM does not require monthly payments, and if you have enough equity, can actually make lifetime payments to you instead. A lump sum of cash may also be available. HECMs require the homeowner complete reverse mortgage counseling through an FHA-approved nonprofit housing counseling agency. Call HUD at 800-569-4287 to find a counseling agency near you.