Refinancing your mortgage can have a significant impact on your financial situation. By refinancing, you can tap into your home's equity, eliminate mortgage insurance, reduce your monthly payments, or shorten the term of your loan. There's no doubt that a mortgage refinance can bring about significant changes to your financial life.

The first step to refinancing is to determine if you're eligible and prepared for the process. Read on to ensure you have all the necessary resources to select the correct type of refinance for you.

Understanding the Requirements for Mortgage Refinancing

Refinancing includes replacing your current mortgage with a new one with a different rate and term using the proceeds from the new loan to pay off the old one.

A cash-out refinance is advisable if you want to borrow more than you owe and receive the difference in cash.

Why You Should Consider Refinancing

Homeowners often choose to refinance their homes for a variety of reasons, such as the following:

• Negotiate a loan for lower payments, interest, or term change.
• Change loan type to a fixed-rate mortgage from an adjustable-rate mortgage (ARM).
• Secure cash to make home repairs or renovations.
• Pay off high-interest credit card debt.

Requirements To Refinance Mortgage

When opting for a refinance, it is crucial to meet specific requirements that vary depending on the type of refinance you choose. If you are interested in cash-out refinance options, your name must be included on the title of your home for at least six months in case you have a Jumbo loan or VA loan. 

You will have to wait a year for conventional or FHA cash-out refinance. However, there are some exceptions to these rules, such as delayed financing or inheriting the home.

Before applying to your mortgage lender, there are several other requirements you need to consider for refinancing.

A Good Credit Score

A credit score ranging from 300 to 850 directly affects your ability to refinance by indicating your creditworthiness. Lenders assess credit scores to determine loan risk and eligibility.

Conventional Refinance Credit Score Requirements

Most of the lenders demand a credit score of 620 or higher to refinance to a conventional loan because the higher your credit score, the better your rate.

FHA Loan Refinance Credit Score Requirements

The minimum median credit score required is 500 to qualify for an FHA loan. However, many lenders approved by the FHA set their credit score limits. 

If you have an existing FHA loan, you can opt for an FHA Streamline refinance to get a lower interest rate quickly without going through a lot of additional paperwork. In many cases, this option may also allow you to continue with a no-appraisal refinance. The streamline option will save you time and money since you have already proven your creditworthiness through your original FHA mortgage.

VA Loan Refinance Credit Score Requirements

Suppose you are interested in lowering your interest rate or changing the term of your loan. In that case, you'll need a median qualifying credit score of at least 580 in order to qualify for a VA loan. Additionally, you can take cash out at this score, provided that you keep at least 10% equity in your home after the refinance. Suppose your median score is 620 or higher; you can take out cash up to the total amount of your equity.

The Department of Veterans Affairs has a loan program that allows veterans to refinance their homes with an Interest Rate Reduction Refinance Loan (IRRRL). 

If you're concerned about refinancing with bad credit, there are strategies to help you qualify.

Substantial Home Equity

To qualify for a refinance, having a good credit score and sufficient equity in your home is essential. Home equity is the amount of the home’s value you own, which would be the proceeds you receive if you sell the property and pay off your mortgage. The more equity you have, the easier it will be to qualify for a refinance.

20% Equity Or More

You should have a minimum of 20% equity in your home if you plan to refinance. You will need 20% equity in your home to eliminate private mortgage insurance. This equity threshold is also typically required if you wish to do a cash-out refinance.

It is crucial to remember that most mortgage lenders only permit borrowers to make use of 80% - 90% of their home's equity for a cash payment. However, suppose you are refinancing with a VA loan. In that case, your lender may allow a higher loan-to-value ratio (LTV) based on your credit score and personal situation. 

Under 20% Equity

If your home equity is less than 20%, but you have a good credit score, you could still be eligible for a refinance. However, you may have to accept a higher interest rate or mortgage insurance. It may be beneficial to refinance even if you have limited equity, especially if the interest rates have decreased significantly since you initially took out your mortgage.

There are no equity requirements for interest-reducing FHA Streamline refinance loans. Still, most circumstances require 20% equity for a cash-out refinance.

Limited Other Debts

 

Your debt-to-income ratio (DTI) is the percentage of your total monthly debt payments as compared to your gross monthly income. This ratio is an essential factor when you are considering refinancing your mortgage.

Lenders use DTI to assess the ability to pay home loans. Total minimum monthly debt includes minimum payments for:

• Car loans
• Student loans
• Credit card debt
• Home equity loans
• Mortgages
• Any other recurring debt

Suppose you're planning to refinance your mortgage. In that case, keeping your debt-to-income ratio (DTI) at 40% or lower is essential, as most lenders prefer it that way. A higher DTI may make it hard for you to qualify for a refinance. If you feel your DTI is high, consider improving your debt before applying for a mortgage refinance.

Affordable Closing Costs

Understanding the cost of refinancing is crucial before making any decisions. The total cost you'll have to pay will depend on your closing costs. These can vary but typically include fees for loan origination, appraisal, prepaid property taxes, title, credit check, and more. Knowing how much you'll need for closing costs will help you make an informed decision about refinancing.

Some lenders may allow you to roll all closing costs into the new mortgage, eliminating the need for upfront payment.

Established Income

Your lender will evaluate your finances and require proof of income to determine the interest rate for your refinance. You can use:

• W-2s
• Tax returns
• 1099s
• Employment history
• Income history
• Pay stubs (past 2 – 3 months)

Co-borrowers on the loan must meet paystub requirements. Lenders verify this information to ensure the future affordability of mortgage payments.

If you’re self-employed, you'll also need to provide:

• Federal income taxes for the past two years
• Profit-and-loss statements

 

This list of documentation is not comprehensive and may not include all relevant materials.

Once you have calculated the numbers and confirmed that you are eligible, it is time to start the mortgage refinancing process. It is important to note that your lender will require you to provide financial details and account information. 

While your credit report provides information on how much money you owe, your lender will also need this information from you. You will need to provide account statements for your mortgage, any home equity lines of credit, car loans, and student loans you may have.