You own your home free and clear – you should be very proud of yourself. Now that you think about it, though, you have hundreds of thousands of your own dollars tied up in your home. What happens if you need to tap into those funds? Can you refinance your home now that you don’t have a loan on it?
Yes, you can refinance your home even without a mortgage on it right now. Because you are not paying off an existing mortgage, it’s a cash-out refinance. This does mean some more restrictive guidelines, but you don’t have a lot to worry about since you already own the home free and clear.
Keep reading to learn the guidelines you’ll likely have to follow.
How Much Can You Borrow?
The first step is figuring out how much you can borrow. As it stands right now, you have 100% equity in your home. Before you get too excited, you won’t find a program that allows you to borrow that much. Since you’ll be taking the entire loan amount as cash, you’ll likely be restricted to around a 70% loan-to-value ratio.
You can determine the loan amount you might be able to receive by determining the fair market value of your home right now. You then take 70% of that amount, that would likely be the maximum amount you could borrow.
Here’s an example:
Joe’s home is worth $300,000. He owns the home free and clear and wants to refinance. He talks to his lender who will allow you to take out as much as 70% of the home’s equity. This means $210,000. He doesn’t have to borrow that much, but he will likely be eligible to if he needs it.
Qualifying for the Refinance Loan
The amount you can borrow for your refinance loan depends on more than just the value of the home, though. It also depends on your qualifying factors, namely your credit score and debt ratio. The required credit score that you will need depends on the chosen program. In general, FHA loans require a 580 credit score and conventional loans require a 620 credit score. The exact score a lender requires will depend on the lender as each lender will differ, though.
Another larger factor is your debt ratio. The credit score lets a lender know how financially responsible you are, although since you paid your mortgage off in full, you already look pretty good in the lender’s eyes. The debt ratio lets a lender know how much of your income is used to cover your bills. Most lenders don’t allow a DTI over 41%, giving borrowers plenty of cushion with their income to be able to afford normal daily living and home maintenance costs.
One factor that could help your debt ratio, though, is if you use the funds from your home to consolidate debt. For example, if you have several credit cards with large balances that make your debt ratio exceed 41% after adding the mortgage, things could be different if you pay them off with the proceeds of the loan. Let the lender know what you plan to do with the funds if you will consolidate debt, as they can figure this into your debt ratio, which could give you a better chance at approval.
The Types of Loans
When you refinance a home you already paid off, you have a couple of options to tap into the cash. You can take the cash-out refinance, much like you would if you had a mortgage to pay off and still wanted some of the home’s equity. You could also secure a home equity line of credit. The HELOC works a little different than the cash-out refinance.
Here’s the difference:
- Cash-out refinance – You will receive the funds in one lump sum at the closing. You are then responsible for putting the money in the appropriate accounts or paying off the necessary debts. The bank does not hold onto the funds for you and you do not receive any future disbursements. You make principal and interest payments right away on the loan, and you can choose from a variety of terms.
- Home equity line of credit – You receive your funds in an account where you can draw on them as needed. It works like a checking account with a debit/credit card. You use the funds and then make payments on the funds you withdrew. You can make interest only payments or pay back the principal and interest and reuse the funds again. You can draw on the funds for the first 10 years of the loan. The remaining 20 years of the 30-year term is the payback period where you make principal and interest payments.
Make sure to weigh your options when refinancing your home without a mortgage. You have several options at your disposal and if you have good credit, you should be able to secure low interest rates and fees. Shop around with different lenders to see what options are available to you.