Refinancing a home mortgage at a lower interest rate will decrease your monthly payment, often by a substantial amount. But for many homeowners, stricter lending guidelines have made qualifying for refinancing tougher. Securing a good refinance rate means meeting these guidelines and convincing the lender that you are still a good credit risk.
You should have a good repayment record, as reflected on your credit report. There should be no defaults, recent delinquencies or collection accounts. The lender will examine your credit score to determine what your interest rate and repayment terms will be.
You will have to show income with W-2s, paycheck stubs or recent tax returns. Your lender will pull a credit report to determine the amount of your outstanding debts, including installment and revolving credit accounts. Your debt-to-income ratio will be evaluated. Traditional lending guidelines state that outstanding debt should be no more than 38 percent of income. If your ratio is too high, you may have to pay off some debts before you can qualify for a refinance.
The lender will also calculate the loan-to-value ratio, which is calculated by dividing the amount of the refinanced loan by the current value of the collateral. For example, if your home is valued at $150,000, a loan of $120,000 gives a loan-to-value ratio of 80 percent. Lenders want to see an LTV ratio at or below 80 percent.
Some loan programs are more flexible than others. The Affordable Home program allows up to a 125 percent loan-to-value (LTV) ratio for borrowers with a good repayment record--meaning no loan payment more than 30 days late in the last 12 months. Borrowers with an FHA-backed loan may also qualify, as a new FHA refinance program does not require a house appraisal.
Finally, you must calculate the new monthly payment and consider the closing costs, which include broker's fees, points and other fees that will add to the cost of refinancing your mortgage loan. Divide the total closing costs by the savings in your monthly payment to arrive at the break-even point, in months. If you don't plan to stay in the home at least that long, the added costs may not make refinancing a worthwhile option.
For a refinance, consider applying with your current lender, who may offer more attractive terms and rates than a new lender would.
Watch out for adjustable-rate mortgages (ARMs) that automatically reset to higher interest rates in the future. Even if you find a "no closing costs" loan, you may end up with a higher monthly payment down the road if the interest rate is adjusted after an initial discount period.