What Should I Do Before Refinancing My Home?

When you are asking yourself, “What should I do before refinancing my house?” you should think back to what it was that you did before you got your existing mortgage. The process of refinancing your home is very similar to the way you financed it in the first place. Approach refinancing your mortgage the same way you would approach taking on a new loan, which means looking at your financial situation again and know your credit score, debt-to-income ratio, and the value of the property. Similarly, prepare for refinancing by paying down debt and increasing your credit score. These things will help you to get the best possible outcomes for when you begin the journey of refinancing your home.
The beginning of the refinancing journey is a Loan Estimate. Similar to a preapproval letter, the lender will look at your financials and give you their terms for a loan based on what you provided. A loan estimate will impact your credit score, but applying multiple within a short period will lessen the impact because credit bureaus will assume you are only looking for one new loan. After giving lenders the basic information on your finances, the estimate is usually ready within three days. Assessing your financial status before heading to this step will help you prepare as much as possible. The strength of the lender’s offer is based on it, and it will affect your credit score. So, now that we know the goal of the preparation work let us look at how we get there.
First, we will look at debt-to-income (DTI) ratios and what they mean. DTI is the balance between your gross monthly income and the total of your monthly debt, such as your mortgage, car payments, student loan debt, minimum credit card payments, personal loan payments, child support, or any other monthly payment. Essentially, the DTI Ratio is a relationship between what is going in and what is going out. A DTI ratio of 20% or lower is considered great, and your expenses are low compared to your income. DTIs upwards of 30 or 40% means the borrower is under financial stress. Lenders will look at this ratio as a means of determining if you are capable of repaying that loan. Lenders can have different DTI requirements because they do not want you to default on the loan, and they do not want to foreclose on your home, which is why they are diligent in their decisions on whether or not to offer the loan. Let us look at a quick example:

• You have a mortgage payment of $1200, two car payments that add up to $500, and a minimum credit card payment of $300, which means that your monthly debt is $2000. Your household’s gross monthly income is $7000, which means your DTI ratio is 28.57%.

With this DTI, you should be in a good place and find it relatively easy to get a loan. In this scenario, your income is high, but if it is any lower, the best option for you would be to start working on the credit card debt. The benefit of this is two-fold; it will not only decrease your DTI ratio, but it will also help your credit score. Your credit score can be improved by lowering your revolving utilization, which is the amount of your credit limit that you are utilizing. In combination with other strategies, lowering credit card debt will help to keep your score high, making your loan offers better. Such strategies include:

• Keeping your usage of any card below 30% of its limit.
• Paying all your bills, including your credit cards, on time because late payments that get sent to collections will lower your score.
• Longer credit history is better, so if you can, leave cards open and pay them down.
• Do not open too many accounts.

Now that we have tackled your DTI ratio and your credit score, we will look at the value of your home. When you refinance your home, the lenders will want to have an appraisal done to assess its value. They do this to ensure the home is worth more than what you owe on your current mortgage. If your home is not appraised for the worth of the loan, it will make for less than ideal loan conditions. This step is just as, if not more, important than the other two. You want your Loan-to-Value ratio to be low, which is the relationship between your mortgage amount and the loan amount, and an LTV of 80% or lower is good. Make sure you are confident that your home will appraise high before starting the refinancing process.
The best possible outcome of refinancing is determined by ensuring that you are well prepared for the process. When you feel confident that your finances and your home are ready, make sure you get multiple Loan Estimates, and then you are on your way to a refinanced home.