We strive to live the American dream of homeownership. Our goals are simple: a few rooms, a place to put down roots and watch our equity grow. People tell us to go out of our way to buy the most expensive home we can afford. We look for what appears to be the cheapest mortgage and pick out a few paint colors. It’s not until a few years later that we realize things are a little tighter than we expected, major home improvements need to be made, and a stubborn credit card debt is weighing on us. Our mortgage is no longer working for us and we need the scoop on how to refinance a home.
What to Gather: Regardless of your situation, you’ll need the following information before contacting a lender:
- Copy of the current loan note (usually a document called a “Promissory Note”)
- The most recent mortgage statement showing the balance of the loan.
- Dollar amount of homeowners insurance and annual property taxes (for escrow calculation) – You can call your city treasurer for tax information.
- Payroll records (for gross and net monthly income).
- List of all other loans and their minimum payments.
- An idea of your credit score (you can request a free report online).
Understand what you can afford: If you are considering refinancing a home loan, you are either. :
- Checking to make sure you’re getting the best deal possible;
- You find yourself in a difficult situation due to job loss, a drop in income, a variable rate loan, or excessive debt;
- You are concerned about the future and want to consolidate your finances before you find yourself in a difficult situation with fewer options.
All three of these situations require you to do a budget to determine exactly what you can afford. Mortgage lenders generously allow borrowers to make payments of up to 28% of their gross monthly income, but this can be far too much for many people. A budget is simply your monthly take-home pay minus all expenses.
Be sure to include everything: loans, utilities, tuition, food, restaurant meals, kids’ lunches, vending machines, entertainment, gifts, subscriptions, medical deductibles. Also, be sure to set aside 10-20% for savings. What’s leftover is what you can afford for your mortgage payments (including tax and insurance deposits). Don’t let a lender convince you that you can afford more.
Choose a lender you are comfortable with: If you are having trouble due to a “difficult” situation (job loss, medical expenses, etc.), contact your current lender first. There is a federal program called “The Making Home Affordable Program” that can help lenders work better with their customers in these situations to refinance a home.
If you just want to get a better rate, shop around. Banks and credit unions are generally very straightforward and use traditional documentation when refinancing a home loan. Most of them want a loan-to-value ratio (LTV) of 80% or more. You can look at websites like Zillow.com to get an idea of what similar homes are priced at in your area. If your loan-to-value ratio is 93.5% or higher, you will need an FHA loan. Mortgage brokers have a variety of loan packages you can consider. The main difference is that with a broker, all loans will be sold to a service, so you will certainly be dealing with a different company after the deal is closed.
If you plan to stay in your home for at least five years, you may want to consider reducing your rate by paying points. Each point represents 1% of your mortgage amount that you pay at closing to reduce your interest rate. Fixed rates are much easier to budget for. Adjustable rates (ARMs) carry uncertainty about future changes in your payment amount. If you choose a variable rate, make sure you understand how far the rates can go, when they can change, and what that can mean for your payments.
Make sure you understand all the terms of your loan agreement and any fees you will be required to pay. Never be afraid or ashamed to ask questions and never settle for an answer you don’t fully understand. One final word of caution: Once you agree to complete a loan application, the lender will pull your credit report. This credit report will help determine the interest rate for which you will qualify.
Too many questions on your credit report can negatively affect your score, so choose the lender(s) you feel comfortable with and answer most of your questions before agreeing to complete a home refinance application.