The process by which homeowners adjust their mortgage loan -- to get a lower rate, to get cash out, or to lower payments -- is called a refinance. Refinancing is fairly common in the United States. Homeowners use the equity in their homes to make large purchases, home improvements, and to pay for college education. If you are considering refinancing, there are some requirements of which you must be aware.
The process by which homeowners adjust their mortgage loan -- to get a lower rate, to get cash out, or to lower payments -- is called a refinance. Refinancing is fairly common in the United States. Homeowners use the equity in their homes to make large purchases, home improvements, and to pay for college education. If you are considering refinancing, there are some requirements of which you must be aware.
Ability to Repay
Most lenders use a debt-to-income ratio (DIR) to calculate your ability to repay a mortgage refinance. To calculate your DIR, divide your monthly expenses (including a proposed payment on a refinance) by your gross monthly income. Many lenders do not like to lend to borrowers who have a DIR higher than 45 percent. Some finance companies will allow higher DIRs, but they might require you to pay more in interest or fees. Income is verified though paychecks and W2s. If you are self-employed, you'll need your Sole Proprietorship Schedule C, or business tax returns, as well as bank statements to confirm cash flow.
Loan to Value
You must have sufficient equity in your home to refinance your mortgage. In addition, your loan-to-value (LTV) ratio must fit within the lender's guidelines. To find your LTV, divide the proposed refinance loan amount by your home's value. For example, if you wanted to refinance into a $300,000 mortgage and your home is worth $330,000, your LTV would be 91 percent. Many lenders are hesitant to refinance properties over 90 percent LTV -- especially in the wake of the 2008 credit crisis. The Federal Housing Authority (FHA), as of December 2009, will not refinanced loans unless they are under 85 percent LTV.
Credit
Credit restrictions vary from lender to lender. At most local banks and credit unions, you'll need to have excellent credit scores. (See Resources for a free copy of your credit report.) While lenders weigh your FICO score (a three-digit number ranging from 350 to 850) the most heavily, they also take into consideration your current mortgage payment history, any past delinquencies, amount of available credit, variety of accounts, and your ability to manage revolving debt. Prior to seeking a refinance, it's in your best interest to review your own credit and attempt to clean up any negative marks that would hinder your ability to qualify.