After crunching the numbers and weighing the costs of refinancing your mortgage, you’ve decided it’s time to take the plunge. But just because you’ve decided refinancing your home mortgage is the best move for you doesn’t mean you’re done with the prep work. You still have to convince lenders that you’re a prime candidate for a new mortgage and they’ll decide if you qualify for refinance. The process is the same whether you have Portland, OR real estate or a home in New York City. Here are some of the metrics you’ll need to meet to be an attractive candidate for a refinancing opportunity.
1. Are you a 20% stakeholder?
Lenders ideally like to see that you’ve got skin in the game — meaning they want you to own at least 20% of the equity of the house.
How do you know whether you have that level of equity? Divide the principal amount that you’re trying to borrow by the value of your house. If your home is valued at $350,000 and you want to borrow $250,000, you have a “loan-to-value” ratio of 0.71, or 71%. That means you have a 29% equity position, with the lender providing the other 71%.
Your lender will most likely order an appraisal to find the current value of your home and perform the above equation. But before that happens, you can estimate the value by looking at recent sales of comparable homes in your neighborhood. If homes for sale in your neighborhood are all listed higher than they were when you applied for your initial mortgage, your home value (and equity) will likely be higher than it was when you bought.
(However, if your mortgage is backed by Fannie Mae or Freddie Mac, or your mortgage is FHA-insured, you may be able to qualify for federal programs that help you refinance, even if you have less than 20% equity. The Home Affordable Refinance Program, for example, helps underwater homeowners refinance, and the program is expected to continue through December 2015.)
2. How high is your credit score?
Most lenders require a minimum credit score of 600 to 650 to approve refinancing applicants; some lenders (such as select credit unions or local banks) demand a credit score of 720 or above.
Your credit score is based on five factors:
- Payment history (35%): Do you make on-time payments?
- Utilization ratio (30%): How much are you borrowing, relative to your total credit limit?
- Length of credit history (15%): How long have you been using credit?
- New credit (10%): Have you recently applied for any new lines of credit?
- Types of credit in use (10%): Do you mostly have installment loans (mortgages, student loans) or revolving loans (credit cards)?
Each of the three major credit-rating agencies, Experian, Equifax, and TransUnion, allow you to view your credit report once per year for free. Make a habit of checking your report once every four months for errors, rotating among these three agencies.
3. How much other debt do you carry?
Lenders look at the monthly payments on all of your debts (including your mortgage, student loans, credit card balances, and car loans) relative to your income. They divide the two figures to craft your debt-to-income (DTI) ratio, and they typically want that ratio to be no more than 38%.
Generally, underwriters want to see the mortgage component of your debts stay within 28% to 30% of your total take-home pay. If you take home $4,000 per month, for example, you should spend no more than $1,120 to $1,200 per month on your mortgage payments. This includes mandatory housing-related fees, such as your homeowners’ association dues.
Meanwhile, the remainder of your debts (such as student loans) shouldn’t push your total above 38%.
Each lender has different requirements, so don’t panic if your DTI is 39%. (And conversely, don’t assume you’re in the clear if you’re at 37%.) Some lenders, for example, allow your DTI to be as high as 45% and the mortgage component to be as much as 33%. Other lenders, however, have more stringent criteria.
The bottom line
Qualifying to refinance your home goes hand in hand with maintaining general strong financial health: Keep your debts low, your credit score high, and build equity.
Have you refinanced lately? Share your tips in the comments below.