One popular way to reduce debts that carry high interest rates — like credit cards — is to use your existing real estate investments to your benefit with a cash-out refinance. This type of loan involves refinancing an existing mortgage, with the new mortgage being greater than the original one in order to provide the borrower with the extra funds they need to pay other bills or reduce other debts. This process can actually improve credit scores if you pay off maxed-out credit cards with your refi. And you may even be able to deduct the mortgage interest from your taxes! To get started, learn about the requirements for this type of loan:
Check Your Credit for a Refi
Knowing your credit score now can help you understand which products are available to you as you work to improve your credit history in the future. You are entitled to free credit reports every year, so be sure to review your history to make sure there are no errors. Although many people believe you have to have perfect credit to qualify for refinancing, the requirements are actually much more forgiving. Typically, you would need a minimum score of between 620 and 680 for a cash-out refinance loan. In general, the lower the credit score, the higher the interest rate for a loan.
How Is Your Equity?
Because you can no longer borrow 100 percent of the equity of your home, you have to do some math to figure out how much you can actually cash out. Most lenders limit the loan to 85 percent of your total loan-to-value. That means if a professional appraiser values your home at $500,000 and you owe $300,000, then you could borrow $125,000 (total value multiplied by .85 minus what is owed equals your available equity).
How to Determine Debt-to-Income Ratio
Keep that calculator out — you also need to check what is called a debt-to-income ratio. Add up the total monthly payment for your house, including any liens or homeowners’ association dues, along with any other debts considered legal liabilities. Then, divide this by your gross monthly income, including bonuses and commission, alimony and rental income. The higher your income and the lower your debt, the lower the DTI percentage. Lenders tend to look for ratios smaller than 50 percent.
Other Documents You Need
If you’ve done the math and think you qualify, the next step is to gather all your paperwork so you are ready to meet with a refi representative. You need pay stubs for proof of income, tax returns and W-2s (or your 1099s) for the last few years, your credit report, a statement of debts and a statement of assets. You want to be prepared when it is time to move forward with a lender, confident you fully understand the process and are making a smart financial decision for yourself.