Whatever your goals are when refinancing your mortgage, there are certain things you should be ready for in order to make the process smoother. We’ll help you know what to expect so we can help you accomplish your goals faster.
Whether you’re looking to take out cash, lower your rate or change your term, this page will walk you through the variables involved in getting ready to refinance and determining whether an option is right for you.
What Are Your Goals With Your Refinance?
The first thing you need to determine is what you would like to do with your refinance. This will help you figure out what programs you might want to look at and which financing option makes the most sense.
Briefly, let’s go over the goals and purposes typically accomplished by refinancing, broken into two general categories: rate/term and cash-out refinances.
A rate/term refinance is used to either lower your interest rate, change your mortgage term or both.
There are factors that affect your personal interest rate. Additionally, all interest rates are influenced by factors in the investment markets. But beyond those, there are a couple of general statements that can be made about mortgage rates. The shorter your term, the lower your interest rate. On the flip side, with a longer term you’ll have a lower monthly payment.
Typically, if rates go down in the marketplace, there’s more interest in rate/term refinances.
When you convert your home’s existing value into cash by taking on a new primary mortgage, this is a cash-out refinance. The purpose of taking cash out generally falls into two categories.
The first big reason that people take cash out of their home is to put it toward anything from a home improvement project to a promising business or investment opportunity to jump starting a college or retirement fund.
A cash-out refinance is also great for consolidating high-interest debt typical of what you might find on a credit card or some personal loans. For example, credit cards often have interest rates that get up into the mid-to-high teens.
In contrast, mortgage rates have consistently remained no higher than the mid-single digits for a little over a decade. Because of this, your mortgage can provide an excellent vehicle for paying off higher interest debt by rolling it into a new loan at a much lower rate.
Costs To Refinance Your Loan
Once you’ve figured out your purpose in your refinance, the next factor to consider is the cost in refinancing. It’s very hard to give an estimate of these costs because everyone’s situation is different. With that said, there are a couple of things we can tell you.
Closing costs on a purchase are typically somewhere between 3% – 6% of the loan amount. The cost of refinancing is typically lower. There are a couple of reasons for this.
For starters, you don’t have to pay a real estate agent as you might on a purchase, depending on your deal with the seller. You also won’t have to deal with the title because that’s not going to change usually.
Additionally, on a refinance, many closing costs can be built into the loan if you choose. This will help keep your costs down.
Your costs are also at least partially dependent on the type of loan you’re getting – conventional, FHA, VA, etc. – because each investor has different fees built in based on things like the loan amount or mortgage insurance.
As you can on a purchase, one thing you can do is choose to pay for prepaid interest points. These help you buy down your interest rate. The key here is to figure out how long you think you might be in the house and then do a little math.
One point is equal to 1% of the loan amount. Let’s say that buying two points will save you $50 per month on your payment. If you have a $200,000 loan amount, two points will cost you $4,000 at closing. You would break even in 80 months. If you plan to stay in your home for at least six years, eight months, it makes sense to pay the points. Otherwise, it doesn’t.
It’s also important to consider any upfront mortgage insurance payments that may have to be made at closing, but these can be built into the loan and we will go over exactly how that works below.
It’s also important to know what you’re looking for when shopping around. For instance, when looking at rates, you’ll see two different numbers. The first is the base interest rates and the second is the annual percentage rate (APR). APR is whatever your base interest rate is with your closing costs factored in. APR will always be higher, but the bigger the difference, the more a lender is charging in fees.
Qualifications For Refinancing
When you’re refinancing, there are several factors to consider qualification wise. There are a variety of differences based on loan type and the options that align with your goals.
This section will go into some of what you need to know.
Loan-to-Value Ratio (LTV)
One very important consideration when it comes to qualifying for a refinance is exactly how much you have in terms of equity. Most loans require you to have at least a certain amount of equity available in order to refinance.
Lenders put these requirements in terms of your LTV. You can think of LTV as the inverse of equity. In other words, if you have 20% equity remaining in your home at the close of your refinance, the new loan has been set up with 80% LTV.
The amount of equity you need to complete a refinance will depend on a number of things including the investor in the mortgage (Fannie Mae, Freddie Mac, FHA, VA, etc.), the loan purpose (rate/term or cash-out), the occupancy status of the property – is this your primary property or a vacation home? – and the number of units in the property.
There are a lot of different scenarios there, so let’s cover some general rules. Your Home Loan Expert will be able to deep dive with you into specifics.
In general, you’ll need to leave more equity in your home if you’re taking cash out than if you’re doing a rate/term refi. With the exception of a VA loan where you can take out up to 100% of your home value provided you qualify, you generally have to leave at least 15% – 20% of your equity in the home if you want to take cash out.
By comparison, with a rate/term refinance, you could only need 3% or 3.5% equity if you just want to lower your rate or change your term depending on the loan type.
If it’s a second home or investment property, you’ll have to have more equity than you would need to refinance a primary property that you live in all the time. For example, on a conventional loan, you can get your rate/term refinance if you have as little as 3% down, but you need 10% down to do a rate/term refinance on a second home and 15% down on a one-unit investment property.
If you have multiple units for a primary or investment property, you may have to have more existing equity to do a refinance. For example, on a primary property with one unit, you would need to leave 20% equity in the home after the refinance is completed. With a multiunit property that increases to 25% equity or 75% LTV.
LTV is important for at least one other reason. You can avoid paying for mortgage insurance.
Most people don’t think of it this way, but mortgage insurance, which is a fee you pay monthly and protects the lender in case you default on your loan, can be a good thing. Because of mortgage insurance, lenders are able to offer you a loan with a lower down payment than they might otherwise have. Still, no one likes paying for mortgage insurance if they don’t have to, so how could you avoid it?
Private Mortgage Insurance (PMI)
On conventional loans, you generally have to pay PMI when your equity following your refinance is less than 20%. However, PMI comes in a couple of different options: borrower-paid mortgage insurance (BPMI) and lender-paid mortgage insurance (LPMI).
BPMI is easy to explain. It’s a monthly fee that’s a percentage of your loan amount that gets divided by 12 and tacked onto your mortgage payment. Once you reach 20% equity, you can request removal pending a reappraisal of your property to make sure your home is worth at least as much is it was when you took out the loan because the calculations are based on the original mortgage amount. More equity would be required to remove mortgage insurance on a multiunit property, or one being used as a rental property.
Additionally, there are circumstances in which you would need to show more equity. For example, when you’re getting mortgage insurance canceled for property value increases based on a significant renovation. In any case, your Home Loan Expert can walk you through the variables involved, whatever your situation.
There’s BPMI, and then there’s LPMI. LPMI is where a lender pays for your mortgage insurance policy in exchange for giving you a slightly higher rate. In a modification of this strategy, you can pay for all or part of your mortgage insurance policy at closing to keep the same rate you would have had without mortgage insurance (or a lower rate in the case of a partial payment.)
It’s important to note that the more equity you have, the less you pay for PMI. This could incentivize leaving in a certain amount of equity even if you can’t leave 20%.
Mortgage Insurance Premiums (MIP)
If you refinance with an FHA loan, you’ll end up paying for something called MIP. It’s an upfront premium paid at closing or rolled into the loan amount that’s equal to 1.75% of the loan. After that, there’s an annual MIP factor split up into monthly installments that’s based on the amount of equity you have when you close. The more equity you have, the lower your fee.
If your initial equity is 10% or more, you’ll pay for mortgage insurance for 11 years on an FHA loan. Otherwise, it stays around for the life of the loan.
VA And USDA Fees
VA loans don’t have mortgage insurance, but they do have a funding fee that can be paid upfront or built into the loan. While the funding fee varies, it goes down if you leave equity in the home after the refinance. The more equity, the better.
It’s worth noting that you’re exempt from paying the funding fee if you are a disabled veteran or the surviving spouse of someone who died in service or as a result of a service-connected disability.
USDA loans have mandatory monthly and upfront guarantee fees for the life of the loan which you can only avoid by refinancing into a conventional or other loan. However, those fees are lower than similar FHA mortgage insurance premiums.
Another big thing lenders look at is your credit score. When you apply for a mortgage, your score and credit report is generally pulled from all three bureaus. Lenders take the middle score for qualification purposes. All scores mentioned in this section will be the minimum median FICO® Score associated with that loan program.
Conventional loans are the easiest to explain because in nearly all refinance scenarios, the minimum qualifying score is 620. Things are pretty straightforward in that regard. There are some circumstances in which a higher score may be warranted, but your Home Loan Expert will get you in the right product.
This is also the qualifying score we use for VA loans that are rate/term refinances and cash-out refinances with at least 10% equity left in the home after the transaction. If you want to take out all of your home value and convert it to cash on a VA loan, you’ll need a 680 FICO® Score. VA doesn’t set a minimum credit score, but lenders set their own policies.
While USDA doesn’t set forth a specific minimum credit score, they apply extremely strict scrutiny to loans with credit scores below 640. At Quicken Loans, 640 is our minimum credit score for a USDA loan. It’s important to note that the USDA doesn’t allow you to take cash out.
If you’re working toward an FHA loan, you can refinance up to a two-unit property through Quicken Loans with a credit score as low as 580. To get approved with a credit score that low, you’ll have to maintain a debt-to-income ratio (DTI) that’s just as low. We’ll get into that a little more below. One key advantage if you’re applying for an FHA loan with a credit score of 620 or above is that you can often qualify with a slightly higher DTI than you could on many other loans. This translates to potentially being able to take more equity out of your home because you qualify for a higher payment.
If your credit isn’t quite where it needs to be just now, we encourage you to check out our friends at Rocket HQ(SM) (1). You can get your free VantageScore® 3.0 score and report from TransUnion® every week. You’ll also get personalized tips based on the information in your report on where and how you can improve your score.
In general, you want your credit score to be as high as possible, because along with your down payment, this is one of the things that has the biggest influence on what your interest rate is.
Income is an important part of the qualification process as well. Your income plays a big role in determining how much you can afford. To illustrate how the process works, let’s go over an example of DTI ratio, which is a comparison of your monthly installment and revolving debt payments to your monthly income.
If you have $72,000 in annual income, that breaks down to $6,000 per month. Let’s say you have student loans with monthly payments totaling $800, a $400 car payment and monthly credit card balances totaling $600. Your monthly DTI before your house payment would be 30%. We recommend that your DTI after your house payment is included is around 45%.
For most of our loans, DTI is absolutely capped at 50% with the house payment included. For an FHA loan, the cap is 38% before the house payment and 45% once the house payment is added in if you have a credit score below 620. At scores of 620 or higher, you may be able to refinance with a slightly higher DTI than you could on most other loans.
It’s also important to consider how much savings you have. As a requirement of getting a mortgage, you usually need to have a certain number of months’ worth of mortgage payments in case you were to suffer a sudden loss of income for any reason. Your mortgage payment includes principal, interest, property taxes, homeowners insurance and any applicable homeowners association dues. You can remember this with the acronym PITIA.
A good general guideline is to have at least two months’ worth of reserves, but more mortgage payments could be required if it’s a second home or investment property. Reserves could also be higher if you have a multiunit property.
If you are getting a primary property, you need less equity and less reserves than you would need for qualification with an investment property or vacation home. With that in mind, how you occupy the property also plays an important role.
What Paperwork Do You Need To Qualify To Refinance?
The qualification paperwork needed for any mortgage is fairly straightforward. As a starting point, we recommend all of our clients get together the following.
- Last two pay stubs
- Two months’ worth of statements for any accounts you want to use toward showing your assets
- Two years of W-2s
- Two years of tax returns
If you’re self-employed and don’t get a W-2, lenders rely on your tax returns and some other documentation that can change depending on the way your business is set up. Check out this article for more information on self-employment documentation.
You may need more of these items. In addition to income and asset documents, certain loans have documentation that’s unique to them. Those who qualify for a VA loan will need to show their Certificate of Eligibility. Find out who qualifies and how to get it.
What Should You Do To Get Ready For An Appraisal?
Usually, you’re going to need to get an appraisal of your property value when refinancing a mortgage. With that in mind, what should you do to prepare for it?
The first thing an appraiser will do is look for any hazardous conditions such as holes in the roof or signs of structural damage that will make the property uninhabitable. Because the property is collateral for the mortgage, if there are any of these problems, you won’t be able to get a loan on the property.
Beyond that, the goal of the appraisal is to place a value on the property because under no circumstances can a lender give you a loan for more than the property is worth.
The value can also impact your transaction negatively if it’s comes in low because it could limit the amount of cash you can take out in order to keep the minimum amount of equity in your home after the refinance. It’s important to have a realistic idea of your local property values in order to determine whether the refinance will help you meet your financial goals.
In order to get ready for an appraisal, it’s a good idea to remember that this is about putting your best foot forward with your home. Appraisers aren’t supposed to take into account cleanliness, but your home always looks best if it’s picked up. If you need to do a paint touch up or some minor repairs, this can be a good way to make sure your home is in tip top shape.
Finally, certain mortgage investors have special appraisal requirements. FHA places a particular emphasis on chipping paint in houses built before 1979 due to the potential for lead paint. Also, VA loans require a pest inspection depending on the type of refinance in most states.
For more on getting ready for an appraisal, check out this article on the process.
We hope this guide has given you some help with things to think about. Of course, every situation is different. One of our Home Loan Experts would be happy to discuss your individual goals and options in detail. If you think you’re ready to refinance, you can get started online or give us a call at (800) 785-4788.
1Quicken Loans® and Rocket HQSM are separate operating subsidiaries of Rock Holdings Inc. Each company is a separate legal entity operated and managed through its own management and governance structure as required by its state of incorporation, and applicable legal and regulatory requirements.