Reasons to Refinance Your Mortgage

Refinancing a home can be a wonderful way to improve your financial situation, lower your payments, or receive the necessary funds for a large investment.

However, there are a few things you need to know before you commit to refinancing your home.

There’s a lot more to refinancing a home than simply lowering your payment, getting cash out, or getting a lower mortgage rate. Keep reading for an in-depth look at everything you need to know when refinancing.

1. There Are Multiple Reasons to Refinance

There are many reasons why you might want to refinance your mortgage. Most reasons center around improving your financial situation in one way or another.

Here are the most common reasons people choose to refinance.

Reduce Interest

You may be able to refinance your loan with a lower interest rate. This is a great way for homeowners to save a substantial amount of money throughout the length of the loan.

For example, a $250,000 home with an interest rate of 4.0 over the course of 30 years will actually cost you $429,673.77. That’s roughly $180,000 paid on interest alone – which is roughly the price of a second home.

A home at $250,000 at a lower interest rate to 3.25, however, would only cost a total of $391,685.69. That’s a savings of nearly $38,000.

Mortgage rates change based on a variety of market and economic conditions. Also, rates depend on a variety of factors including the loan to value, credit, cash out, and the type of mortgage product. Find out what you qualify for.

Reduce Monthly Payments

One of the best things about refinancing your home is that you can use it to lower your monthly mortgage payments.

This is, of course, assuming you don’t use the refinance to take out cash against the equity. However, if you refinance the loan based on what you owe and receive a lower interest rate and payment, it could save you hundreds of dollars each month.

CURRENT CASH OUT REFINANCE RATES

Reduce the Length of the Loan

If your financial situation has improved and you can afford higher mortgage payments each month, you could refinance to reduce the length of the loan.

While you may wonder why you would want higher monthly payments, think of it in terms of the total cost of a 15-year loan versus a 30-year loan.

Using the same example as above, a $250,000 home at 4.0 percent interest over 30 years would cost $429,673.77 when all is said and done.

That same home at 4.0 percent interest over a 15-year loan would only cost $332,859.57. You would be saving nearly $100,000 in interest by opting for a 15-year loan.

For reference, a 30-year loan would require monthly payments of $1,193.54, while a 15-year loan would require monthly payments of $1,849.22.

Consolidate Debt

If you meet the refinance requirements and have a decent amount of equity in your home, refinancing may be a brilliant way to consolidate high-interest debt into your low-interest mortgage.

For example, the average American has over $5,000 in credit card debt at a typical interest rate of 19 percent.

Other loans and debts have equally high-interest rates. If you could refinance your home and use the positive equity to absorb those debts under a lower interest rate, it could save you thousands of dollars.

Additionally, using a refinance to consolidate your other debts will likely lower your total monthly payments.

Take out Cash Equity

While it’s not always recommended, some people refinance their home to take cash equity out of their home’s total value.

This can be done to make larger investments such as second homes, businesses, or remodeling.

Receive a Home Equity Line of Credit

Some homeowners refinance their homes to take out a HELOC or home equity line of credit. These are typically used to upgrade or renovate the home in some way. This includes bigger projects such as updating an entire kitchen or bathroom, creating more outdoor living space features, adding rooms onto the house, and more.

This can be looked at as a good investment, as these updates and renovations also serve to further increase the value of the home.

Revert From an ARM to an FRM

Finally, you can use a refinance to change your adjustable-rate mortgage to a fixed-rate mortgage. This can be a wise move for homeowners who are planning on staying in the home long-term and want to lock in a low-interest rate.

2. You Need to Do Some Homework

Before you refinance your home, you need to make sure you know what you’re getting into and whether or not it’s even an option. Here are a few bits of homework you need to accomplish before you get too far ahead of yourself.

Know Your Financial Situation

Do you have a high enough credit score to get approved for a home refinance? If your goal is to change from a 30-year loan to a 15-year loan, are you sure you can afford the higher payments?

Know the Market

Is now the right time to refinance? The real estate industry fluctuates like any other based on the economy. What are the average interest rates lenders are offering to borrowers?

Before refinancing, make sure the economy is leaning in your favor to get the lowest interest rates possible.

Know Your Home’s Value

You may be asking yourself “How much equity do I need to refinance?” An accepted rule is that you should have at least 20 percent positive equity. However, that’s not to say you can’t refinance with less.

Ultimately it comes down to your particular circumstances (credit score, home value, the purpose for refinancing, etc.).

3. Credit and Income Requirements

When it comes to refinancing requirements, your credit history is one of the most important. But what is the minimum credit score required to refinance?

While there are some lenders that will let you get away with less, generally you need a credit score of 640 or higher to refinance a home with a traditional refinance. However, a lot of your applicability depends on your circumstances such as LTV (Loan to Value) DTI (Debt to Income), and Credit.

For example, if you’re applying for a loan with a spouse or other co-signer, you may have better odds. Additionally, the value of your home and what you’re looking to get out of the positive equity can affect the process.

4. Understand the Cost vs Benefit

It’s important to look at the big picture when refinancing a home. Refinancing is far from free. You need to understand that refinancing your home is essentially taking out a new loan, which includes the same fees.

For example, expect to pay a few thousand dollars at the end of the process for:

  • The new appraisal and inspection of your home
  • Application/fees
  • Document preparation fees
  • Recording fees
  • Loan origination fees
  • Title search and title insurance fees
  • And more

However, these costs are often built into the refinance so they will be paid through your mortgage, rather than facing any true “upfront” costs.

All of the costs will be clearly explained in the Loan Estimate.  We always caution customers against quotes over the phone or verbally. The loan estimate is designed to clearly allow you to see all of the closing costs, the APR (Annual Percentage Rate), and the exact terms of the loan.

5. Does Refinancing Reset the Length of the Loan

In most cases, refinancing does replace your current loan with a new loan.

However, there are products for a variety of mortgage terms and not just your standard 15 year fixed rate mortgage or 30 year fixed-rate mortgage.

If you have been paying for 7 years why start over at a 30 year fixed-rate mortgage.

That is why many lenders have created fixed-rate mortgage products for any term length.

6. Understanding Discount Points vs Lender Credits

Mortgage points also known as discount points are fees that are paid to the lender for a reduced rate. This is often called buying down the rate or a rate buy-down.

Lender credits can go toward closing costs such as title and escrow but usually will come with a higher interest rate.

You may need to run some numbers to determine if the amount you’re saving on interest is worth the upfront cost of mortgage points.

We always recommend talking with a mortgage professional as several factors come into play depending on your specific goals.

7. You Don’t Have to Refinance Through the Same Mortgage Company

Finally, one of the best things about the refinance requirements is that they don’t include using the same mortgage company as your original loan.

That means you can shop around with multiple lenders to get the best rates possible.

You may even be able to get approved through one lender when another has turned you down.

Be careful not to apply for too many loans, which can hurt your credit. The pre-approval process, however, does not affect your credit score.

Additionally, keep in mind that you can use one lender’s offer to negotiate with others to talk them down on prices, interest rates, and more.

Be sure to get a Loan Estimate when considering refinancing. Anyone can provide a quote on the phone, but the loan estimate or LE was designed to allow you to compare mortgage terms and clearly see the term, interest rate, APR (Annual Percentage Rate), and closing cost.

Do You Meet All of the Refinance Requirements?

If you and your home meet the refinance requirements, you’ve come to the right place.

Choice Home Mortgage exists to help people like you refinance their homes to pull out cash equity, pay off debt, consolidate debt, lower their interest rates, and more.

Apply now to see what you qualify for or call us with any questions or concerns

Documents needed to Refinance Mortgage

If you’re considering refinancing your home, you must provide proof of your income, assets, employment, and liabilities. Just like you did when you bought your home, you must prove you can afford the new loan. So what documents are needed to refinance your home?

Keep reading to learn everything you’ll need to refinance

Income Documentation

Before you gather your documents for a refinance, you must determine the type of income you have. Borrowers working for someone and those who are self-employed have different documentation requirements.

W-2 Borrowers 

W-2 borrowers usually work for someone else on a salary or hourly basis. They report their earnings on a 1040 tax return and have a third party that can verify their income.

If you work for someone, you must provide your paystubs covering the last 30 days (usually 2 paystubs), the last 2 years of W-2s, and 2 bank statements proving regular receipt of your income.

Self Employed 

If you own 25% or more of a business, you are considered a self-employed borrower. In some cases, self-employed borrowers receive a combination of income including W-2 reportable income, K1 distributions, and other income types.

Because self-employed income is less consistent and isn’t verifiable by a third party, lenders take a larger risk of lending to you. To ensure you qualify for the loan, they do their due diligence to ensure the income is stable and reliable. This typically means proving a history of receipt for at least the last 2 years.

In addition, lenders require the last two years of your personal and business tax returns. This includes the 1040s and all schedules (all pages). You must also provide a year-to-date profit and loss statement to prove your current year’s income is on the same track too. Your P&L must be on company letterhead and be signed and dated.

Most self-employed borrowers must also provide a statement from a third party that can verify their income, such as a CPA.

Retired or Pension 

If you’re retired, you may still be able to get a mortgage, but different documents are needed to refinance. You must be able to prove you have a steady income and that it will (or should) continue for at least the next 3 years.

To prove your retirement or pension income, you must provide your Social Security award letters, pension statements, and current proof of receipt of the income, such as the last two months’ bank statements. You may also need to prove the continuation of the income if there’s any question it won’t continue.

 

Income documents needed to refinance a mortgage 

The table below shows the most common documents needed to refinance a mortgage.

W2 Borrower 
  • Last two years W2’s 
  • Two Most Recent pay stubs- Covering 30 days. 
  • Bank Statements tracing the deposit of net Income. 
Self Employed (Ownership of 25% or more of a business) 
  • Last two years personal 1040 tax returns 
  • Last two years business tax returns (1120’s if LLC or S Corp) 
  • Two most recent years W2’s if paid a salary out of the business. 
  • Two most recent pay stubs- if paid a salary. 
  • Signed and Dated YTD profit and loss statement.  (P&L) Must have company name and the dates/periods the P&L covers 
Retired or Pension 
  • Last two years 1040’s tax returns  
  • Most recent Social Security award letter  
  • Pension Statement  
  • Last two years 1099R  
  • Last two months bank statements showing deposits of income. 

Asset Documentation

Each loan program has different asset requirements. Some loans require you to have a few months of reserves (full mortgage payments) available. All loans require you to have money for a down payment and the closing costs.

Even if your loan program doesn’t require reserves, you must prove where you’re obtaining the money for the down payment and closing costs.

Below are common asset documents needed to refinance.

Bank Statements

You’ll typically need the last two months of bank statements to prove your assets. Lenders look at your recent deposits and withdrawals and may question anything out of the ordinary, such as large deposits or large withdrawals.

Your deposits should coincide with your income. If they don’t, be prepared to provide a paper trail of the deposits to prove they aren’t a loan and/or that the money belongs to you.

IRA Account Portfolio

If you’re using your IRA as your proof of assets, you must provide the most recent monthly statement showing the balance. Lenders may use around 70% of the balance to account for taxes and penalties you may face if you withdraw the funds.

401K Documentation

During the application process, the lender will need to pull what is known as a tri-merge credit report. This will show your credit scores and history across all three major credit bureaus (Experian, Equifax, and Transunion).  

The contents on the credit report are used to verify all debts and will be calculated in the debt-to-income ratio. 

Investment Account Documentation

If your money is in an investment account, you must provide documentation proving the balance and that the money belongs to you. Unlike retirement funds, lenders may use a higher percentage of the balance since there aren’t penalties. Some lenders use 100% of the balance and others use slightly lower percentages to account for balance fluctuation.

Employment Documentation

When you’re wondering what documents are needed for a refinance, don’t forget to document your employment. This is a big factor in your loan application since lenders must determine if your employment is secure and stable.

To document employment, you must provide lenders with your employer’s name and contact information in addition to your paystubs or proof of your income.

Lenders have one of two ways of verifying your employment:

·      Verbal verification of employment – A verbal VOE means the lender calls your employer to verify you work there on the dates you stated. They also ensure you are presently employed.

·      Written verification of employment – If the lender needs more information about your employment and/or income, they may send a written Verification of Employment request to get more information about your income and time at the company to ensure you are a good risk.

Proof of Debts and Credit

Along with the above documents needed to refinance, lenders must determine what debts and credit you have outstanding. You’ll disclose this information on your application, but they must have proof with a tri-merge credit report.

When you apply for a mortgage, the lender asks for your permission to pull your credit from all three credit bureaus – Trans Union, Equifax, and Experian. They use this information as a baseline to determine your eligibility for a loan.

Along with the information provided on the credit report, you may need to provide your most recent account statements for any liabilities with a different payment amount than the credit report shows or if you recently paid off any accounts still showing a balance on the credit report.

The information provided in the credit report helps lenders calculate your debt-to-income ratio to ensure you qualify for the loan.

Mortgage Statements and Proof of Insurance

When you refinance, you must prove your housing payment history for the house you’re refinancing as well as any other properties you own.

You must disclose all properties you own and the amount of financing/monthly payments on each.

Valid Government Issued ID and Social Security Card

Along with the financial documents needed to refinance, you must also prove your identity. Lenders require a copy of your driver’s license or other government-issued ID. This proves you are the person on the loan.

Also, to complete your refinance process, you must sign and date the closing documents. To do this, you must provide proof of your identity (a government-issued ID) with your Social Security card to a notary who will witness you signing the documents to ensure that you are the person named on the loan.

How the Mortgage Refinance Process Works

To refinance your loan, you must complete a loan application, just like when you bought your home.

The difference is this time you already own the home and just want a different loan on it. The reason you are refinancing will determine what documents are needed to refinance.

Reasons to Refinance

Homeowners can refinance for many reasons, but here are the most common:

  • Rate/term refinance – This refinance pays off your existing mortgage and replaces it with a mortgage for the same amount. You refinance strictly to get a better interest rate or better term, such as refinancing from an ARM to a fixed-rate loan.
  • Cash-out refinance – This refinance taps into your home’s equity. You can usually borrow up to 80% of the home’s value. If you paid your mortgage down and/or the home appreciated, you may have room to take cash out for debt repayment, home renovations, or other expenses you need money for.

Once you determine the reason you’re refinancing, the lender will determine which documents are needed to refinance.

Along with your documents, lenders will look at a couple of metrics to determine your ability to repay the loan. Knowing what lenders need can help you best prepare for your loan application.

Factors Lenders Consider to Refinance your Loan

Credit Scores

Lenders first look at your credit score. Like we said above, they make sure your credit score meets the loan program’s requirements and that you have a history of paying your bills on time.

Each loan program requires a different credit score, but on average, you should have a 640-credit score or higher for the best chances at approval.

Debt-to-Income Ratios

Lenders next look at your debt-to-income ratios to make sure you can afford the loan. A DTI is a comparison of your monthly debts to your gross monthly income (income before taxes).

Which debts are included in your DTI and how lenders determine your income depend on several factors.

Lenders include all debts in your DTI that report on the credit report. Common examples include minimum credit card payments, car loan payments, student loan payments, mortgage payments, and alimony/child support payments. They don’t include expenses such as utilities, insurance, food, or clothing.

How lenders determine your income depends on how you receive it. If you’re self-employed, they may take a 2-year average of your income to account for seasonality or cycles. If you work for someone, they’ll take a 12-month average of your income to determine your gross monthly income.

Typical DTI Limits

Each loan program has different DTI limits, just as they each have different credit score requirements. Here are the most common DTI limits for popular loan programs.

Fannie Mae <50%
FHA 31% / 43%FHA Refer/Eligible Purchase & Refinance

 

FHA Streamline Credit Qualifying

37% / 47%

·       If the client meets residual income requirements or has 3 months reserves:

·       FHA Refer/Eligible Purchase & Refinance

·       FHA Credit Qualifying Streamline

 

38% / 45% FHA FICO 580-619 Purchase & Refinance

 

50% FHA Streamline Non-Credit Qualifying
Jumbo 40-43%
VA 45%-60%

What is Conditional Approval? 

Once you provide lenders with the documents needed to refinance, they’ll process your application and qualifying documentation, providing you with a conditional approval.

The conditional approval means the loan is approved as-is, but before you can close, you must satisfy any conditions they state in the letter.

The most common documents for a refinance to clear up a conditional approval include:

  1. Updated Paystubs
  2. Updated homeowners’ insurance declaration page
  3. Letter of Explanation on any disputed tradeline or accounts
  4. Other documents that may be required to support income requirements
  5. Updated bank statements
  6. Proof mortgage is current

At Choice Home Mortgage we shop the rate for you through our network of wholesale lenders.

Our mortgage professionals and processing staff will review your unique situation to find not only the best rates but structure the loan so that we can get it funded fast. We help streamline the documents needed to refinance by matching you with loans you qualify for with reputable lenders.

To learn more get started now.

7 Things You Need to Know Before You Refinance Your Mortgage

From time to time, mortgage rates drop and reach record lows. The COVID-19 pandemic is an example of an event that resulted in a significant drop in interest rates.

However, COVID-19 also made it more difficult for self-employed borrowers due to uncertainty in economic conditions.

If you’re considering refinancing your mortgage, now is a great time as mortgage rates are near historic lows.

Before you rush into it here are 7 things you need to know before you refinance your mortgage.

Knowing the requirements before you apply can help you learn whether you qualify for a refinance loan or not.

Here are the top seven requirements to understand before you apply.

1. Have a Valid Reason or Tangible Benefit.

Many of our customers find a benefit to refinancing. This includes a lower mortgage payment, taking cash out, reducing the interest payments on the loan or paying of the house early.

To Obtain a Lower Interest Rate

What is the interest rate on your mortgage? If it is higher than the current rates available, refinancing is the only way to take advantage of the lower rates.

When you refinance, you get a new loan with a new interest rate. A lower rate will result in having lower mortgage payments and will help you pay less money in interest.

If you want lower mortgage payments and can get a lower interest rate through refinancing, then you should consider going through with it.

Always work with a mortgage professional. There are many factors to rate such as credit, loan to value, and lender credits vs discount points. Finding the right solution to meet your specific goals is why mortgage brokers like Choice Home Mortgage exist.

To Switch to a Fixed-Rate Mortgage

The second reason people consider refinancing is to switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan. ARMS are unpredictable, and that is the one feature people dislike about them.

With a fixed rate, you will never have to worry about your rate increasing. You will have a steady mortgage payment amount for the life of your loan.

To Take Cash Out

Refinancing as a way to take cash out of your home is also a valid reason.

You can do this if you have equity in your home.

Taking cash out can be used to pay off high-interest debts, start a business, remodel the house, or for investment purposes.

To Eliminate Private Mortgage Insurance

You can also eliminate private mortgage insurance (PMI) by refinancing if you have enough equity in your home.

If you’re tired of paying PMI and feel that your house is now worth enough, refinancing is the ideal way to stop your PMI requirement.

In most cases, you will need to bring the loan to a value below 80% to remove PMI.

2. Meet the Financial and Credit Requirements

When refinancing, you must also meet financial and credit requirements

To do this, you must prove you can repay the loan.

You must also prove that you are creditworthy enough for the lender to approve your loan application.

Here are some details to know about each category:

Financial Requirements

One part of the application process is providing application documents such as W2, Paystubs, Tax Returns, Award Letters and other proof of income.

Lenders also calculate ratios when evaluating a person’s finances. One popular ratio is the debt-to-income (DTI) ratio.

The answer to this ratio reveals how much debt you must pay compared to the income you earn. If your DTI is too high, you will not qualify for a mortgage loan.

It is also important to show two years of consistent income. Most lenders will average your income over two years when calculating DTI.

Self-employed borrowers, you will also need to have both your personal tax returns and business tax returns if you own more then 25% of a business. We also recommend to have your accountant prepare a year-to-date (YTD) profit and loss statement (P&L).

Credit Requirements

Lenders also have credit score requirements for loan approvals. You might want to know what credit score is needed to refinance, but there is not just one universal answer to this.

The credit score you need depends on the loan program you plan to use. If you use an FHA loan for the refinance, you would need a lower score than if you used a conventional loan.

It’s also wise to look at your credit score before applying, so you have an idea of where you stand. You’ll likely need a score of at least 600 to qualify for most loan types.

3. Provide the Necessary Documentation

Many lenders will require a full and complete package before they review and conditionally approve. A complete package typically includes the following items:

  • Pay stubs
  • W-2s or tax returns
  • Current financial statement
  • Current Mortgage Statement
  • Proof of Insurance
  • Copy of ID
  • Award Letters
  • IRA or 401K Statements.

Your lender will supply you with a list of the documents you must provide with your application. Additionally, the lender will ask you to sign documents that allow them to verify your employment, income, and credit.

You need the same documents to apply for a refinancing loan as you do when applying for a loan to buy a house.

4. Meet the Timing Requirements

In most cases, you can refinance at any time. However, some lenders may require you to wait at least six months from the date you took your original loan if refinancing with the same lender.

5. Prove You Have Enough Equity Through an Appraisal

Most lenders have requirements in place that relate to the value and equity of a home. Lenders set these guidelines to avoid issuing loans for amounts that are higher than the values of the homes.

To find out how much equity you have in your house, subtract your mortgage balance from the home’s current value. If you owe as much as the house is worth, you have no equity in the property. Getting a loan, in this case, would not be easy.

Lenders place a lot of value on equity amounts when approving all types of mortgage loans, including new home purchases. If you feel you have enough equity, you can apply now for a refinancing loan.

Depending on if you are getting cash out, the type of loan product, and loan to value we may be able to get what is known as a PIW (property inspection waiver).

6. Review the Cost vs Benefit

There is always a cost to refinancing. However, oftentimes lender credits can offset or cover some of the costs. In most cases, borrowers never have to come out of pocket and the cost can be rolled into the loan.

Cost can include:

  • Loan origination fee (paid by borrower or lender)
  • Appraisal fee
  • Title and escrow fees
  • Credit check fees
  • Recording fees
  • Underwriting and processing fees

All costs will be clearly provided in the loan estimate, commonly referred to as the LE.

Lenders often offer lender credits to help offset the costs. It is important to work with a mortgage broker or wholesale lender like Choice Home Mortgage and will shop with the top lenders to find the best possible deal to match your unique situation. 

7. Plan to Stay There Long Enough to Make It Worthwhile

Finally, you should consider one last thing before refinancing – how long you plan to stay in this house. Because you must pay fees to refinance your loan, you should make sure you live in the house long enough to recoup these costs.

To determine the answer to this, you can use a simple calculation:

  1. Add up the closing costs you must pay to refinance
  2. Determine the amount you will save per month on your new house payment
  3. Divide your total closing costs by the amount you save each month

The answer you get reveals the number of months it will take for you to recoup the closing costs you paid to refinance. If the answer is 30, it means it will take 30 months to recoup the costs.

In this case, if you are planning on selling your house in one year, refinancing would not be worthwhile. If you plan on selling in three years, refinancing would be advantageous.

Take Advantage of Low Rates by Applying for a Refinance Loan

If you have a legitimate reason to refinance, and if you believe that you meet the refinance requirements, contact us.

We offer all kinds of mortgage loans and can help you find the right option for your situation. Visit our site for more information about our services, products, and interest rates, or give us a call to learn more.

Cash-Out Refinance Guide

Cash-out Refinance

If you’ve owned your home for a while, you’ve probably earned some equity in it. With today’s low rates, you may be eligible to tap into that equity, using the money you’ve earned in the home, putting it to good use with a cash-out refinance.

Check out our complete guide on cash-out refinancing below.

What is a Cash-Out Refinance?

A cash-out refinance is a loan with a loan amount higher than your current mortgage. It provides the opportunity to tap into your home’s equity, using the difference between your loan payoff and the new loan amount as you wish.

Like a traditional mortgage, the mortgage cash-out loan uses your home as collateral. To be eligible, your home must be worth more, and/or you must have paid your loan balance down, so you have equity in the home.

Equity is the difference between your home’s current value and your outstanding loan balance. You earn equity each month as you pay your mortgage down and as your home value increases.

How Does Cash-Out Refinancing Work?

When you use the cash-out refinance option, you refinance your current first mortgage with a new mortgage. The new mortgage has a higher loan balance, new term, and a new interest rate. You may even get a cash-out loan from a new lender.

The new loan pays off your existing mortgage and takes its place as the first lien position. The difference between the amount used to pay off your first mortgage (and any fees you wrap into it), is yours, which you receive as cash.

How do you Qualify for Cash-Out Refinancing?

Every lender has its own set of requirements, but in general, here’s what you’ll need.

An Average Credit Score of 620+

Lenders take a larger risk when giving you a mortgage cash-out loan. They lend you more money than you borrowed, assuming you can pay the loan back. A higher credit score shows lenders you are responsible for your finances.

Each loan program has a different credit score requirement, but on average you will need at least a 620, but a higher credit score earns you better terms and lower interest rates.

A Low Debt-to-Income Ratio

Your debt-to-income ratio compares your total monthly debts to your gross monthly income (income before taxes). The lower your DTI, the less risk of default you pose. On average, lenders prefer a DTI of less than 50% when considering cash-out refinancing.

If you have compensating factors, such as great credit or you borrow less than 80% of the home’s value, you may get away with a slightly higher DTI.

There are also multiple ways to calculate the I (income) in DTI depending on if you are self-employed or not. This includes using bank statements, business income, and even asset depletion from investment accounts.

Home Equity

This goes without saying. You can’t borrow from your home’s equity if you don’t have any equity in it. Overall, you can borrow up to 80% of the home’s equity. This includes your current first mortgage.

For example, with a conventional mortgage, if your home is worth $200,000, you can borrow up to $160,000. If your first mortgage has a balance of $100,000, that leaves you with $60,000 in equity that you can withdraw.

However, there are newer products such as Non-QM and Non-Conventional products that you may be able to borrower up to 100% of your home’s equity.

How Soon can you Refinance and get Cash Out?

Some loans may require you to wait at least 6 months before you take equity out of your home. This depends on many factors such as FHA, VA, Conventional, USDA, or Non-Conventional loan. We always recommend speaking with a mortgage professional as oftentimes guidelines and overlays on cash-out refinancing are changing.

What can you use a Cash-Out Refinance For?

A mortgage cash-out loan has many uses. Every homeowner has a different reason for using their home’s equity and there is no right or wrong way to use it, but here are the most common ways.

  • Home renovations – Using your home’s equity to fix up your home can be the best use of your home’s equity. You reinvest in your home, possibly increasing its value, earning your money back that you borrowed from the home.
  • Debt consolidation – If you have high-interest credit card debt, you may feel like there’s no light at the end of the tunnel. Consolidating your debt with a low-interest mortgage may lower your monthly payments, and consolidate the number of bills you have each month.
  • Invest the money – Some homeowners want the equity out of their home to invest the money elsewhere. If you know of ‘other investments that may earn money faster than your home appreciates, you can withdraw the funds to invest it.
  • Emergency fund – If you don’t have liquid assets on hand, liquidating your home’s equity may give you peace of mind should a financial emergency occur.

Who Benefits from a Cash-out Refinance?

Homeowners with equity in their home can benefit from a cash-out refinance if:

  • A lower interest rate is available than their current interest rate.
  • There is enough equity in the home to borrow the funds needed.
  • The funds will be used to make home renovations that may improve the property’s value.
  • Using the equity will make managing monthly debts easier by consolidating high-interest consumer debt.
  • Using the equity to start a business or for an investment.

Like any mortgage program, there are pros and cons to the cash-out refinance. Knowing the ‘good and bad’ will help you decide.

Pros of the Cash-Out Refinance

  • With a cash-out refinance you may get a lower interest rate. Today’s rates are lower than we’ve seen in decades. Even if you take out a larger loan amount, you may lower your current interest rate and save money overall.
  • You may be able to consolidate debt with a cash-out refinance. No one likes paying 19 – 24% on credit card debt. If you can consolidate your debt into your home equity, you can save money on interest charges.
  • If you use the funds to improve your home, you may have tax benefits. If you itemize your deductions, mortgage interest can be something you write off.
  • You can get money for any use with a cash-out refi. Whether you need money for an emergency fund, another investment, to buy another property, or to pay for college, you can use the funds as needed.

Cons of the Cash-Out Refinance

  • Your interest rate may increase with a cash-out refi. Depending on your credit score and other qualifying factors, you may get a rate higher than you have now, which means a much higher mortgage payment.
  • Wrapping your consumer debt into your home mortgage drags out the repayment for 15 to 30 years, which may mean more money paid on the debt over the long haul.
  • You put your home at risk. If you default on your mortgage because it’s a higher loan amount and payment, you may lose your home.
  • You may be tempted to use money that isn’t necessary. Using your home as a piggybank can lead to needless spending and other financial issues.

Alternatives to the Cash-Out Refinance

A mortgage cash-out loan isn’t the only option when you need money. Here are the alternatives:

• Home equity line of credit – A HELOC taps into your home equity, but as a second mortgage, leaving the first mortgage alone. A HELOC works like a credit card – you get a credit line that you can use or leave untouched. You only make interest payments on the funds you withdraw, and you can use the line for up to 10 years.

• Home equity loan – A home equity loan provides your home’s equity in one lump sum rather than a line of credit. You make principal and interest payments right away, which makes it easier to budget.

• Personal loan – A personal loan is usually unsecured, unlike the HELOC or home equity loan. Because it’s unsecured (no collateral), you’ll pay higher interest rates and may face tougher requirements.

• Credit card – If you have credit cards with a high credit limit, they are an option but know the APRs. If you have a 0% APR for a certain amount of time and you know you can pay the balance off by then, it could be a good option. Otherwise, credit cards can get expensive and hard to pay off.

Is a Cash-Out Refinance Worth It?

A cash-out refinance can be the answer many homeowners need. If you’re in over your head in debt, want to make home improvements, or just want money on hand, now is a great time to tap into your home’s equity.

Like any mortgage or real estate transaction, make sure you know the fees, rate, and loan terms before you proceed with a cash-out refinance. Take the shortest term you can and make sure you’re getting the interest rate you deserve based on your credit score and other qualifying factors. Using your home equity for big financial decisions can be a great way to use the largest investment in your life – your home.