You’ve finally decided it’s time to refinance your old mortgage, but due to some vague misgivings, you haven’t actually started the process yet. What’s holding you back? Maybe you don’t have your financial house in order and, consequently, you don’t feel ready to refinance, even though you know you should.
If that scenario sounds familiar, you’re worried about whether you’ll qualify or you’re just dreading the paperwork, here are six things you need to do right now.
First up to refinance: credit report
Most people have credit reports on file with each of the three main credit bureaus: Equifax, Experian and TransUnion. You’re entitled by law to at least one free credit report from each bureau every 12 months. You can access your free reports at AnnualCreditReport.com. Review each report carefully, paying close attention to your open and closed credit accounts and any derogatory items, such as late or missed payments or a foreclosure or bankruptcy. If you find any material errors, notify the bureau and ask to have the error corrected.
Check your FICO credit score
A credit score is a three-digit number produced by an algorithm that crunches the data in your credit reports. There’s no one credit score that’s an automatic yes or automatic no to refinance, but a higher score should help you secure a lower rate. Focus on FICO rather than other scores since most of the largest U.S. lenders use FICO. You can purchase your FICO score from FICO.com or you can get it free from a credit card company or third-party website (e.g. Credit Karma) that offers it.
There are variations of the FICO score, so the one you get might not be an exact equivalent of what your lender will see. If your FICO’s on the low side, you’ll need to improve your credit habits to boost your chance of refinancing. Use a variety of credit types, make all of your payments on time and in full, and don’t max out any of your credit accounts.
Document your income and assets
Another important factor lenders consider when you refinance is your ability to make your mortgage payment. To demonstrate your ability to pay, you’ll need to provide documents that illustrate your income and assets. There’s no one fixed list of documents your lender will require. Instead, every lender has slightly different guidelines. Examples of documents you might be asked to provide include:
- Paycheck stubs
- W-2 forms
- Bank statements
- Investment account statements
- Profit-and-loss (P&L) statement if you own a business
- Rental agreements if you own rental property
- Federal income tax returns
Typically, you’ll have to sign a Form 4506, which allows your lender to get transcripts of your tax returns directly from the IRS.
If you want to use alimony or child support as income to refinance, you may need to provide copies of court documents that order your former spouse or child’s parent to make those payments to you.
Pay down your debt
Your lender will also want to know whether you can manage other debt you currently have. To evaluate this factor, the lender will calculate your debt-to-income ratio, or DTI. If your monthly minimum payments to service your debt eat up a large percentage of your income, you might have to pay down some of your debt or produce documentation of additional income before you can refinance. Calculating your DTI isn’t a do-it-yourself project. You’ll need to talk to your lender to find out whether your DTI is in the go-zone or no-zone.
Calculate your LTV
When you refinance, your lender will consider your property as well as your creditworthiness. That’s because your property is the lender’s collateral for your loan. Key property factors include your
- home’s current market value
- requested new loan amount
- loan-to-value (LTV) ratio
Here’s an example of these four factors:
Market value: $400,000
New loan amount: $300,000
LTV: 75% ($300,000 /$400,000)
Equity: 25% ($100,000 / $400,000)
If you’re eligible for a VA loan, guaranteed by the U.S. Department of Veterans Affairs, you might be able to borrow 100% of your home’s value. Otherwise, you’ll typically be limited to a slightly lower LTV. If your LTV is higher than 80%, you may be required to pay for mortgage insurance for your lender.
While you can’t control your home’s market value, you can—and should—stay aware of comparable property values in your neighborhood and invest in your home to keep it well maintained and up-to-date.
Now that you’ve reviewed your credit, gathered your documents and calculated your LTV, you should feel better prepared to refinance your home mortgage.