How2Day: Limits on Refinancing

It might make sense to refinance your mortgage loan when interest rates fall. Refinancing a 30-year fixed-rate $200,000 mortgage loan from one with an interest rate of 7 percent to one with a rate of 5 percent will save you more than $256 every month in mortgage payments. That comes out to a savings of more than $3,000 a year. Before you can take advantage of these savings, though, you must meet certain requirements. Conventional mortgage lenders have certain limits on the refinances that they'll approve.

The biggest limit that you'll have to overcome when it's time to refinance a mortgage loan is the amount of equity you have in your home. Most conventional lenders require that you have at least 20 percent equity in your home before they'll approve you for a refinance. This can be a problem if your home's value has fallen since you bought it. If this has happened, you might not have the equity you need to secure a refinance from most mortgage lenders or banks.

Lenders also limit the amount of debt that borrowers can have when they refinance. That's why they'll figure your debt-to-income ratio. This ratio, as its name suggests, compares the amount of your monthly debt with the amount of your gross monthly income. For a refinance, most lenders require that your monthly debts, which include your new estimated mortgage payment, total less than 36 percent of your gross monthly income.

There's a reason for this: Lenders think that you'll be more likely to default on your new mortgage loan if your debt levels already eat up too much of your monthly income.

Credit scores have become crucial to any homeowner attempting to secure a mortgage loan or refinance one. Lenders have limits as to how high a credit score you must have to obtain a mortgage refinance. These limits vary, but most lenders require that your FICO credit score be above 700 to earn the lowest interest rates. This is important: If you can't qualify for the lowest interest rates, a refinance rarely makes sense.

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