Refinancing a mortgage can reduce your monthly payments, get you out of debt sooner, or let you tap into more home equity. However, mortgage lenders have several requirements you have to fulfill to qualify. Some of these requirements are self-imposed, while lenders abide by Fannie Mae and Freddie Mac requirements for other financial products. This guide will explore what it takes to qualify for a refinance.
The Importance of Understanding Refinance Requirements
It can take a while to apply for a loan and submit all of the necessary paperwork. Even after all of that effort, it’s possible to get your application rejected. While lenders use several factors when determining your eligibility, you don’t want to waste time applying for a loan that you won’t receive.
For instance, applying for a refinance with a 620 minimum FICO score requirement doesn’t make sense when you only have a 550 FICO score. You will need a 620 FICO score to secure a conventional loan, but FHA loans are more generous. Knowing the requirements can help you save time and determine what you have to do to boost your chances of getting approved.
Overview of Refinance Eligibility Criteria
Lenders have several requirements that you must fulfill to get a refinance. It’s good to know what lenders want before submitting applications, as you can end up with a lower interest rate and better loan terms. These are some of the most common eligibility criteria for mortgage refinances.
Credit Score and Credit History
Mortgage lenders will review your credit history to determine if you make on-time payments and do a good job of managing your debt. A 620 FICO score will help you get most refinances, including a conventional refinance. However, you can get an FHA refinance if you have a 580 credit score. VA loans have no minimum credit score requirement, but most VA lenders will only approve your application if you have a 620 credit score or higher.
Employment and Income Stability
You must typically show at least two years of consistent employment to increase your chances of receiving a mortgage refinance. It’s preferred if you have been in the same industry for those 2+ years, but it’s possible to get a refinance if you were employed at different companies over the past two years.
Debt-to-Income Ratio
Lenders have different DTI ratio requirements depending on the type of loan you want. You can typically receive most types of refinances if your DTI is below 36%. However, some lenders will work with you for certain loans if you have a DTI ratio of 50%. You can improve your debt-to-income ratio by earning more income or paying off some of your financial obligations.
Home Equity and Loan-to-Value Ratio
Lenders limit how much home equity you can tap into for a refinance. You typically cannot exceed a 90% loan-to-value ratio for your property. This ratio measures your loan’s balance against your property’s value. If you have a $500,000 property and a $400,000 mortgage, you have an 80% LTV ratio. Lenders that limit you to a 90% LTV ratio will only let you access an additional $50,000 worth of equity in this scenario. Having less than 10% equity in your home will make it difficult to receive financing.
Common Documentation Requirements
Mortgage lenders request several documents as a part of the application process. These documents will give mortgage loan providers more information about your finances. Make sure you have these documents before applying for mortgage refinances.
Income Verification Documents
You will have to present documents to verify your income. Lenders will review these documents to assess if you can make monthly mortgage payments on the refinanced loan. These are some of the documents you may have to provide.
- Pay Stubs and W-2 Forms
- Tax Returns
- Employment Verification
- Asset Verification
- Bank Statements
- Investment Accounts
Property Appraisal and Insurance
You must get a home appraisal to receive a mortgage refinance. Lenders will also want to see your home insurance before approving your application.
Additional Documents
It’s possible that your lender may request documents beyond the ones outlined earlier. These are some of the additional documents your lender may request:
- Proof of rental income from investment properties
- Documentation related to applicable bankruptcy, child support payments, or alimony payments
- Letters that explain employment gaps or credit history issues
Costs and Fees Associated with Refinancing
Refinancing can be expensive. These are some of the fees to anticipate when you get a new loan for your property.
Application Fee
You will incur an application fee when applying for a refinance. This expense typically ranges from $75-$300.
Loan Origination Fee
Loan origination fees are costs incurred for creating the loan and the backend tasks. This origination fee can range from 1% to 1.5% of the loan’s balance.
Appraisal Fee
An appraisal fee can cost a few hundred dollars. Lenders will want you to cover an appraisal so they know how much equity you have in your home.
Closing Costs
Closing costs include several fees like title services, credit check fees, recording fees, and others. You’ll pay these costs when you close in on the loan.
Prepayment Penalties
You will likely owe prepayment penalties to your current mortgage provider when you pay the balance in full. It’s common for mortgage lenders to charge you extra if you pay off your loan before the term’s maturity date.
Challenges with Refinancing Requirements and How to Overcome Them
Although a refinance can reduce your monthly payments and let you access home equity, you still have to qualify for them. These are some of the roadblocks borrowers face during the process.
Low Credit Score
A low credit score will limit your options, especially if your FICO score is below 600. Most mortgage lenders want to see a credit score of at least 620. Consumers with low credit scores may want to hold off on applications and rebuild their credit before applying for refinancing. Even if you get approved, you will likely end up with a higher rate for your new mortgage.
High Debt-to-Income Ratio
Mortgage lenders will also review your debt-to-income ratio to determine if you can juggle a mortgage refinance with your other financial obligations. A high ratio, especially one that is above 50%, can make it difficult to get a refinance.
Homeowners seeking cash-out refinance will face an uphill battle, as increasing their mortgage’s balance will result in higher monthly payments, assuming no other changes are made. Homeowners may have to add more years to the backend of their mortgages to fulfill the lender’s DTI ratio requirement.
Insufficient Home Equity
You need enough home equity to get approved for a refinance. You shouldn’t have any issues if you have at least 20% equity in your home. However, lenders may reject your application if you have less than 10% equity in your home.
Finding the Best Rates
You’ll have to shop around and apply for multiple mortgages to discover the best rates and terms. It can take a while to get a good rate, especially if you barely qualify with your FICO score, DTI ratio, or home equity. Homeowners shouldn’t rush to accept the first offer they receive. It is a good idea to look around and see what mortgage lenders are willing to offer.
Why Lenders Have Varying Refinance Requirements
Mortgage lenders incur risk with every loan they give out. Lenders make money as borrowers make monthly mortgage payments, but those payments become too much for some people, resulting in foreclosures. Lenders get ownership of the property if a borrower cannot make loan payments, but the lender typically sells at a loss. Too many foreclosures can threaten a lender’s business model and force them to shut down.
Lenders use various requirements to increase the likelihood of working with borrowers who can afford monthly payments. While working with a consumer who has a 450 FICO score will result in short-term profits, this consumer is more likely to default. You only get a bad credit score if you fall behind on payments and have a high balance. Similarly, a high debt-to-income ratio indicates an individual may be at risk of falling behind on mortgage payments and potentially defaulting in the future. Lenders do not want to contend with those risks and set the bar high to minimize foreclosures.
