MarketWatch Picks has highlighted these products and services because we think readers will find them useful. Links in this article may result in us earning a commission, but our recommendations are independent of any compensation that we may receive. Learn more
Many experts think mortgage rates will rise in 2022, but they are still very low now — some 15-year refi rates are near 2% and some 30-year rates are below 3% — and that’s tempting many Americans, who haven’t already, to refinance. But you’ll need to be a certain type of borrower to snag those low rates. Here’s what lenders are looking at to figure out what interest rate to charge you to refinance.
What are some of the factors lenders look at when deciding on the interest rate for a refinance?
1. Credit score
This is among the most important factors, says Denny Ceizyk, LendingTree’s senior staff writer for mortgages. “In general, a score of 740 [or higher] will snag you the best mortgage rate,” says Ceizyk. And Greg McBride, chief financial analyst at Bankrate, recently told MarketWatch Picks: “Credit scores of 700 and above have an easier time qualifying, with the best terms available to those with credit scores of 740 and above. While it’s possible to refinance with a credit score between 620 and 680, the terms aren’t nearly as good.
2. Debt-to-income ratio
Your debt levels and your income are important too, as measured by your total debt-to-income ratio. “The DTI ratio is calculated by dividing your total debt by your before-tax income, and conventional leaders can’t approve a loan with a DTI ratio above 50% in most cases,” says Ceizyk; and it’s more common that lenders want a DTI of about 43% and below. “However, government-backed FHA and VA loans may allow more leniency. Homeowners with current FHA and VA loans may be eligible for streamline refinance programs that don’t require any income verification or a home appraisal,” he adds.
3. Payment history
Lenders are also looking at your payment history, says Holden Lewis, home and mortgage expert at NerdWallet. Many people paused their mortgage payments during COVID as the government allowed borrowers to go into forbearance without penalty, and some lenders want to see those restarted. “In normal situations, lenders want borrowers to have paid on time for the last 12 months before they can refinance. But the rule is different for those who went into a mortgage forbearance plan. Regulators want them to be able to refinance and save money, even if they couldn’t make full payments during the pandemic. So homeowners who took a mortgage forbearance can be eligible to refinance once they’ve made three on-time payments under the terms of their repayment plan after exiting forbearance,” says Lewis. This applies to mortgages backed by Fannie Mae, Freddie Mac, the FHA and the USDA. Homeowners with VA loans may be able to get a streamlined Interest Rate Reduction Refinancing Loan (IRRRL) to refinance as soon as they get out of forbearance, as long as their financial hardship has ended. “This policy is a lifesaver for people who had to sit out last year’s refinance boom because they were in forbearance,” says Lewis.
4. Loan-to-value ratio
Another thing that can have a big impact on the rate you’re offered is the loan-to-value (LTV) ratio. “This measures how much of your home’s value you’re borrowing against, and the higher the LTV, typically the higher the rate and harder it is to qualify,” says Ceizyk. To calculate your LTV ratio, divide the amount borrowed by the appraised value of the property. If you have a loan balance of $140,000 and your home is appraised for $200,000, your LTV would be .70 or 70%. The industry standard for a good LTV is generally a ratio of 80% or less.
5. Other things lenders considers
Lenders may also look at things like your assets (if you have, say, lots of cash in the bank, this can tip the balance in your favor), experts say. They’ll also want to verify your employment, will look at whether you’ve had a number of recent credit inquiries on your account and more.
How much might I be able to borrow?
If you’re refinancing to get a lower rate or shorter term, most lenders will limit your loan amount to 95% of the home’s value or lower, says Lewis. “So if your home is worth $300,000, the maximum loan amount is $285,000 which is 95% of what it’s worth. That requirement isn’t much of a stumbling block for most homeowners, because home values have gone up so much in the last year. But if you’re getting a cash-out refinance, most lenders limit you to borrowing 80% of the home’s value, or $240,000 on a home worth $300,000,” says Lewis.
What are some things that trip up borrowers looking for a refinance?
As for unexpected things that might trip you up when refinancing, Ceizyk says a low appraisal value is usually the most common bump in the refinancing road. “Your interest rate could rise, or you might not get as much cash-back with a cash-out refinance if the home value comes in lower than your estimates,” says Ceizyk.
A low credit score is also a likely source of refinancing problems. “Mortgage lenders check credit information from at least three credit bureaus, and take the middle of the three scores. This may come as a surprise to borrowers who rely on a credit score app that only tracks one credit bureau,” says Ceizyk.
Not having enough money for cash reserves can also present an issue if you have low credit scores and high debt ratios. “Lenders may require you to have some rainy day funds in the bank to make sure you can cover the first couple payments on a new loan,” says Ceizyk.