BILLS 5 Steps to Qualify for a Home Refinance Loan
Anyone who took out a mortgage loan to purchase a home knows that good preparation was a key to a smooth mortgage process. Proper preparation also improves your chances for getting the best rate available.
In order to get a good rate, you have to have solid income, low debt, and good credit.
Qualifying for a home refinance loan is similar to qualifying for any mortgage loan. Lenders look at your ability to repay (your debt-to-income ratio), your willingness to pay (your credit score and credit history), and the amount of security you bring to the loan (your loan-to-value ratio).
You may consider refinancing for a number of reasons, including the reasons listed in the chart below:
|Type of Home Refinance Loans||Reasons for Refinancing|
|Rate and Term|| |
In addition to the above reasons:
In order to help you qualify for a home refinance loan at the best rates possible, follow Bills 5 steps:
- Build your budget
- Improve your DTI ratio
- Learn your credit score and history
- Learn your home’s value
- Shop around
Build your Budget
In order to qualify for a home refinance loan you will need to show that you have good stable income, a good payment record and equity in your property. Before you start shopping around, prepare yourself by creating and maintain a budget. Use Bills.com personal budget guide to get you started or refine you budget process.
Your personal budget will provide you with a framework to analyze your monthly expenses and provide answers to the following questions:
- How much is your monthly housing payments? (mortgage, property taxes, property insurance, and other housing expenses)
- How much is your monthly debt payments? (credit cards, installment credit, student loans, auto loans)
- How much are you saving per month?
- Can you cut back on expenses and either increase your savings level or decrease your debt level?
Improve your DTI Ratio
One of the most important criteria in qualifying for a home refinance loan is your DTI (debt-to-income) ratio. Your DTI is determined by dividing your total monthly debt payments by you total gross income. Lenders use two formulas, as follows:
- Front-end DTI: This DTI only looks at your monthly payments towards your home, including your mortgage payments, property insurance, property tax, and HOA fees if applicable)
- Back-end DTI or your total DTI: This includes all your payments in your front-end DTI and all reoccurring monthly debt payments, including your minimum credit card payments, auto loans, student loans, and installment credit, divided by your monthly gross income.
In general, conventional loans require ratios of 28% / 36% for a front-end and back-end DTI. However, Fannie Mae, for example, allows for a DTI ratio up to 45%, given strong compensating factors.
In order to increase your chances of qualifying for a refinance home loan, and getting a better interest rate, check your DTI ratios. Your budget will make this an easy task. If you DTI ratio is too high, then:
- Avoid taking on new debt.
- Pay off your credit card debt. Make sure that you are not stuck in the minimum payment cycle, but are maximizing your payments to pay off your debt quicker. Use Bills.com minimum payment calculator to help you plan your payments.
While improving your income is more difficult, remember, that a lender will look for stable income. The underwriting requirements for qualifying income are complicated. If your income is seasonal, or depends on yearly bonuses, then your lender will have stricter requirements. Also, if you are changing jobs (unless within the same industry), or just opening up your own business, then your chances for approval are diminished.
Learn your Credit Score and History
Qualifying for a home refinance loan and getting a good interest rate depends on your credit score and credit history. Most loans require at least a credit score of 620 or more, although a FHA loan has less strict requirements. However, as of May 2012, most conventional loans require a credit score of at least 640.
Monitor your credit score: I recommend that you monitor your credit report. You are entitled to a free credit report through www.annualcredit.com, once a year, from each of the big three CRA (credit reporting agencies), Experian, TransUnion, and Equifax. Although these reports do not include your credit score, it is important to monitor your credit report and remove any incorrect information that will hurt your credit score.
Your credit report contains positive credit tradelines and negative accounts, which generally remain on your report for 7 ½ years. (Bankruptcies and public judgments will remain longer). If you have incorrect information, then read Bills.com article about disputing a credit report.
Improve your credit score: If your credit score is low, then you can improve your credit score by taking the following actions:
- Make sure all your payments are on time.
- Dispute incorrect items
- Pay off collection items, as most lenders will not approve a loan if you have collection items on your credit report. However, if the old item is a old, the statute of limitations may be over.
For more tips, read Bills.com article about how to improve your credit score.
Learn your home’s value
In order to qualify for a home refinance loan your lender will evaluate how much equity you have in your home. When looking for a home purchase loan the lender used your available down payment to help determine the size of your loan.
Calculate your LTV ratio by dividing your loan balance by the value of the property, for example:
- Current loan balance: $220,000
- Current value of property: $320,000
- LTV: 69%
Here are a couple different scenarios depending on the type of home refinance loan you want to qualify for:
- Rate and Term Refinance Loan: If you are looking for a rate and term loan, then you can refinance without Private Mortgage Insurance.
- Cash out Refinance: If you are looking for a cash-out refinance home loan, then you can take up to $36,000 without mortgage insurance.
Here are some general rules about LTV (loan-to-value) and qualifying for a home refinance loan:
- If you are underwater, then it is difficult to qualify for a home loan. There are currently a few programs available including:
- Conventional loans are limited to 80% LTV, although with mortgage insurance, it is possible to refinance at higher levels. Cash-out refinancing have more strict terms.
- FHA refinance loans go up to 97.5% LTV (with mortgage insurance) and cash-out home refinance is limited to 85% LTV. Before you apply for a refinance home loan, learn your home’s value by looking at online Web sites and talking to local brokers.
In order to qualify for a refinance home loan, you will need to meet all the underwriting criteria including having sufficient credit scores, income, DTI, credit history, LTV. If you want to do a refinance home equity loan or a cash-out refinance loan, then you will need even better qualifying ratios.
You are one-step closer to your home refinance loan by doing your homework and preparing yourself by following the first four steps (Budget, Improve your DTI ratio, Learn about your credit score and history, and Learn about your LTV).
Your final step is to shop around. Different lenders have different credit requirements, as well as different interest rates. For many borrowers, it pays to refinance at todays’ low interest rates. When you are ready to shop for your refinance home loan, get a mortgage quote from Bills.com mortgage providers.