Refinancing your mortgage is just like getting your purchase mortgage. The only difference is that you own the home now – you aren’t trying to purchase one. What does this mean for the type of documentation you must provide a lender?
You’ll provide a large majority of the same paperwork, just updated this time around. Even if you refinance with your current lender, they will need to document your ability to afford the loan. There are a couple of exceptions to this rule, which we’ll discuss below so that you can determine which loan is right for you and so that you have the proper documentation.
Proof of Income
First, you must prove your income. This is how lenders know that you make enough to cover the cost of the mortgage, plus your other monthly debts.
If you aren’t self-employed, you’ll provide the lender with:
- Paystubs covering the last 30 days of employment
- W-2s for the last two years for all jobs
- Tax returns if you work on commission
If you are self-employed, you won’t have paystubs or W-2s. In this case, you’ll need to provide your last two years of tax returns with all schedules. This lets lenders see how much income you claim as well as how many expenses you deduct. Lenders must use your adjusted gross income to qualify you for a mortgage if you are self-employed.
Lenders may also need a Verification of Employment. This is verbal or written verification of your employment with an employer or proof of your self-employment. If you work for someone, your lender will either call your employer and ask a few questions or request that they complete a Verification of Employment form, which confirms the information that you provided to ensure its legitimacy. If you are self-employed, your lender will likely require a letter of verification from the CPA that does your accounting/taxes.
Proof of Debts
The lender will also need to see what other debts you have at this time. They do this with the credit report, which serves two purposes. First, the credit report lets lenders know if your credit score is high enough to qualify for the program. Typically, you need the following scores for the standard refinance programs available today:
- Conventional loans – 680
- FHA loans – 580
- VA loans – 620
- USDA loans – 640
Lenders also use your credit score to see the amount of debts that you have outstanding. They use this information along with your income to determine your debt-to-income ratio. The DTI helps the lender determine if you qualify for the loan.
Lenders look at two debt ratios – the front-end and back-end ratio. The front-end ratio is the comparison of the potential housing payment to your gross monthly income. The back-end ratio is the comparison of your total monthly debts including the new housing payment to your gross monthly income. Typically, you must meet the following debt ratio requirements in order to qualify for a mortgage:
- Conventional loans – 28% upfront ratio and 36% total debt ratio
- FHA loans – 31% upfront ratio and 41% total debt ratio
- VA loans – 41% total debt ratio (they don’t specify an upfront ratio)
- USDA loans – 29% upfront ratio and 41% total debt ratio
Proof of Funds for Closing Costs
You must prove that you can afford the closing costs the lender charges for the refinance. Most refinance loans have some amount of closing costs, unless you negotiate a no-closing-cost loan. Even then, you may have to come up with the money to cover the cost of your real estate taxes and homeowner’s insurance.
Typically, you can prove your funds with the last two months of bank statements from any account that you’ll use funds to pay the closing costs. It’s best if you have all of the funds in one account. This way you only have to provide bank statements for one account. Be careful, though, if you transfer funds from one account to another within 2 months of your loan application, you’ll have to prove the origination of the transferred funds so that the lender knows the funds aren’t from a loan.
Proof of Reserves
Many loan programs don’t require you to have assets to qualify for a mortgage, but it can help you qualify for the loan if you have other questionable qualifying factors. For example, if you have a debt ratio that is slightly higher than the allowed DTI for the loan program you need, but you have assets on hand, it could be what the lender needs to qualify you for the loan.
Lenders count your assets based on the number of months of mortgage payments it can cover. For example, if your mortgage payment is $1,000 and you have $5,000 on hand, you have five months of reserves.
If you will use assets to help you qualify for a loan, you’ll need to provide the last two months of your bank statements with all pages (even blank pages) included. Lenders use this to see any deposits you’ve made recently to determine if there are any outstanding loans that aren’t reporting on the credit report yet. They also use it to make sure the money you claim that you have is yours (you didn’t borrow from someone else just to make your account look larger).
Letter of Explanation
In some cases, you may need a Letter of Explanation written to the lender. This letter helps the lender better understand unique circumstances.
For example, if you had a few late payments on your credit report from a year ago, the lender may want to know what happened. Writing an official LOX lets the lender see what happened. It’s also an opportunity for you to provide documentation proving the situation. For example, did you fall ill and had to take a leave of absence from work? This may result in lower pay, which if it’s the reason you didn’t pay your bills on time, you can prove to the lender. They want to see concrete proof of the reasons you fell behind as well as proof that you’ve picked up the pieces and moved forward in a positive manner.
In addition to the above documents, you’ll typically need to pay for an appraisal as well. The appraisal lets the lender know the value of your home so that they can determine if there’s enough collateral in the home for them to give you a loan. The more documentation you provide the lender with upfront, the faster your refinance can get through the approval process.