Refinance Loan Mortgage Basics
Learn about Refinance Loan Qualification
Income, Credit, Equity, and Home Loan Documentation
People refinance their home mortgage for many reasons. You may want lower mortgage rates, shorter home loan repayment terms, cash-out, have a mortgage balloon payment coming due, or want to switch to a fixed-rate home loan from an adjustable rate mortgage.
The major qualifying factors for a home loan refinance are Income, Credit, and Equity, also termed "ICE". These three areas will determine the types of home loan refinance programs and resulting mortgage rates you are eligible for.
More accurately, it is the mix of these areas that determine the types of home loan refinance programs for which you qualify and the resulting mortgage rates.
For instance, you can have a relative low income and low equity interest in your home, mixed with a high credit score. This will qualify you for multiple refinance home loan program options and competitive mortgage rates.
Let's take a closer look at the components of ICE and it's effect on
home loan refinance programs and mortgage rates.
Refinance Loan Income Informtion
Your gross monthly income is used to derive an important qualifying ratio called the "Debt to Income" ratio.
There are two calculations. The first or Front Ratio is your housing expense-to-income ratio. This is your proposed mortgage payment (principle, interest, taxes and insurance) divided by your gross monthly income.
The second is termed the Back Ratio and is your TOTAL monthly obligations-to-income ratio. This is your total monthly payment obligations, including Mortgage PITI divided by your gross monthly income.
Total monthly obligation expenses are found by adding all monthly expenses from your credit report .... such as auto payments, credit card payments, etc .... plus your monthly property taxes, monthly homeowner's insurance, and proposed new monthly mortgage payment.
Historically, the debt-to-income ratio needed to be at .28 or lower for the Front Ratio, and .36 or lower for the Back Ratio to qualify with a conforming refinance mortgage lender (28/36).
Conforming refinance lender programs now allow higher Back and Front Ratios, sometimes as high as in the .40's for Front Ratio and into the .50's for the Back Ratio. Beginning in 2014, the Back Ratio will be trimmed down to .43 for most lenders.
Qualifying with higher debt-to-income ratios depends upon other factors, such as the borrower's credit report, Loan-to-Value ratio, and the lender's specific program underwriting guidelines.
If your DTI ratios are in the .40's or even .50's, your best bet is to have your lender run your refinance scenario through the Automated Underwriting System (AUS), to determine an approval decision within minutes.
Since conforming home loans typically carry the lowest refinance rate, it will be a few minutes time well spent!
Subprime home loan lenders have home loan programs that allow up to a .55 Back End DTI, but are becoming a scarce option in recent times. Subprime home loan mortgage rates are typically higher than conventional mortgage rates.
FHA home loans have a standard maximum qualifying Front/Back DTI of .31 and .43 (31/43). As with conforming loans, FHA will allow higher Back and Front End Ratios depending upon the borrower's credit report, Loan-to-Value ratio, along with other factors, so have your lender run their home loan scenario through the FHA AUS for an approval decision within minutes.
FHA home loan refinance mortgage rates are very competitive for those with low credit scores.
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To "Cash-In" on this Historical Opportunity with a
Refinance Home Loan
Fully Documented Refinance Home Loan. W-2's, tax returns, and Social Security annual award statements are some typical documents required to show proof of monthly income for a fully documented home loan.
Since a Full-Doc home loan qualifies for the lowest refinance mortgage rates, full-doc is the most popular refi choice for home loan borrowers.
Full Doc Refi: W-2 Wage Earners
W-2 wage income earners typically need to have a solid two-year work history in the same line of work with no gaps in employment.
For hourly workers, income for qualification will be capped at your base hourly pay and overtime pay will only be included if it is expected to continue for the next 12 months and verified by your employer. This also holds true for any yearly bonus amounts, but must be verified to be received for an additonal 2 years in most cases.
SSI, Alimony, and Child Support can also be included toward gross income, but the borrower must provide supporting documentation that the payments will continue for at least another 3 years.
Full Doc Refi: Self-Employed
Self-employed individuals need to be in business for at least two years. The income allowed for a home loan is the bottom line on your federal tax return AFTER all the Deductions. You can add back such items as depreciation.
Documentation requirements for self-employed are typically as follows:
Sole Proprietorship: 2 years 1040's with all schedules.
General Partnership: 2 years 1040's with all schedules, 2 years 1065's (partnership returns), and Schedule K-1.
Limited Partnership: 2 years 1040's with all schedules and Schedule K-1.
Corporation (IRS 1120): 2 years 1040's with all schedules, 2 years W-2's from corporation, and 2 years 1120's (corporate returns)
S Corporation (IRS 1120S): 2 years 1040's with all schedules, 2 years 1120's (S corporation returns), Schedule K-1.
*** A YTD profit and loss schedule may also be required depending upon lender and whether the loan application is dated within 120 days of the end of the borrower's business tax year.
Again... SSI, Alimony, and Child Support can also be included toward gross income, but the borrower must provide supporting documentation that the payments will continue for at least another 3 years.
Stated Income Refinance Home Loan. Many self-employed individuals file tax returns that are not truly reflective of their actual earnings, due to normal business deductions and write-offs.
Self-employed individuals have the option to simply "state' their income, providing their credit score is high enough (some lenders will allow a stated income loan with a credit score as low as 640 but requirements are getting stricter by the day).
A Stated Income home loan will carry slightly higher mortgage rates than "fully documented" refinance home loan options.
Of course, self-employed individuals can qualify for a Fully Documented refinance home loan (lower mortgage rates) if their tax return's "adjusted gross income" is adequate for the qualifying DTI ratio.
Self-employed individuals require proof they have been in business for at least two years to qualify for a home loan. A CPA letter or DBA (Doing Business As- Filed with the County) will suffice.
No (Low) Doc Refinance Home Loans: Keep in mind, the more income, employment, asset and credit history documentation you provide to your refinance lender, the lower the mortgage rates may be.
Borrowers that opt for a No Doc or Low Doc home loan are those that have high credit scores, but don't prefer to have their complete financial information presented to the mortgage lender.
A No Doc refinance home loan requires the least amount of information, and doc requirements can be as little as providing your social security number and property information.
A No Ratio home loan appeals to those who do not wish to disclose their income, but have adequate assets and an excellent credit score. The mortgage lender will not consider the debt to income (DTI) ratio for this refinance loan type.
For a Nina home loan (No Income No Asset), income and assets will not be considered by the mortgage lender, but employment will be verified.
Reduced documentation refinance loans will require a minimum credit score of 680-720 in most cases, and may also cap the amount of equity you can borrow against your home's appraised value to between 80% and 95%, depending upon the specific home loan program.
Mortgage rates will be higher compared to a Full-Doc home loan.
Update: Reduced and "No Documentation" loans have disappeared from the market due to the high risk for lenders.
Refinance Loans and Credit Scores
Mortgage lenders rely heavily upon credit scores for mortgage rates qualification and credit worthiness.
In most cases, the "Mid" FICO score is used as the primary score for a home loan. This is simply determined by using the middle FICO score from the three major credit reporting agencies: Experian, Trans Union, and Equifax.
The credit reporting agencies use complex mathematical algorithms utilizing such factors as credit mix, credit balances relative to total credit limits, missed and late payments, judgements, collections, and the age of credit accounts to determine your score.
There can be a wide range in scores between the three agencies, hence, most refinance lenders rely upon the middle score. Scores can range from 300 to 850. Higher scores equal lower mortgage rates.
Refinance Loan Equity Calculations:
The appraised value of your home, minus what you owe on your existing mortgage(s) (includes 1st and 2nd home equity mortgages), equals the amount of equity you have in your home.
For example, your home has an appraised value of $100,000 and you owe $60,000 on your mortgage. $100,000 minus $60,000 gives you a $40,000 equity interest in your home.
A common equity-based calculation called the "Loan-to-Value" ratio, or "LTV", is used to determine qualification for home loan refinance programs and to make adjustments to qualifying mortgage rates. The lower the LTV, the lower mortgage rates you may get.
LTV is determined by dividing your total loan amount by the appraised value of your home.
For instance, your total loan amount is $75,000 and the appraised value of your home is $100,000. The LTV would be 75% (75,000 divided by 100,000), and you would be left with a 25% equity interest in your home.
You will qualify for more refinance programs and receive lower mortgage rates as your LTV percentage decreases.
The higher the LTV, the more risk to the mortgage lender, as you have less of an equity interest in your home. That said, there are a number of high LTV home loans (up to 100%) on the market that have competitive mortgage rates, provided that you have a good credit score and meet income requirements.
Equity: Home Value and Appraisal
Home value is crucial to your refinance home loan. It will qualify your Loan-to-Value ratio and be a major factor in determining the refinance programs for which you are eligible.
How do I find my Home's Value?
There are a number of free online home valuation sites that will give you an idea of the value of your home. Zillow.com is one of the more reliable and accurate of the free sites, and its easy to use.
Keep in mind that free online home value estimates cannot replace the need for an actual home appraisal. The apprasial is of course, a lender requirement, but also gives protection for the borrower.
You do not want to borrow more than your home's value, and be upside down on the mortgage, particularly if you plan on selling your home or refinancing in the future. The appraisal is meant to proctect both the lender, and the borrower from this scenario.
Do not assess your home's value based on "homes for sale" in your area because the final sales price may be significantly lower than the home's listing price. Also, the home for sale might appear similar to your home, but in fact, may not be a comparable home for appraisal purposes.
Home Appraisal Factors
The apprasier will consider many factors in determining the appraised value of your home.
Appraisers weigh the location of the home, its proximity to desirable schools and other public facilities, the size of the lot, the size and condition of the home itself and recent sales prices of comparable properties, among other factors.
The recent sales prices of comparable properties carries the most weight of any other factor. Lenders usually want to see 3 comparables within a mile or two from the subject property, but it is not uncommon for a five mile radius to be used when there are not enough comparable homes in close proximity.
Home Appraisal Cost
Most conventional home loan appraisals will cost between $400 and $500, depending upon the regional location and the particular apprasier. The appraisal fee for a FHA home loan will typically cost between $450 and $500.
Apprasier fees can cost a bit more for properties valued at over $500,000.
Refinance Loan Rates and ICE Recap
Income: Income affects refinance program qualification, but not mortgage rates. If the refinance program qualifying DTI ratio is met, a higher than required income will not qualify for lower mortgage rates.
Credit: Credit scores affect mortgage rates and refinance program qualification. The higher your score up the Credit Tiers , the lower your mortgage rates.
Equity: The amount of equity in your home affects mortgage rates. An LTV under 80% qualifies for the lowest refinance mortgage rates. For every 5% interval in LTV over 80%, mortgage rates will increase.
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