With interest rates at historic lows, homeowners are presented with an incredible opportunity to save a tremendous amount of money by locking in low payments for the next 30 years. At the end of February, the average interest rate for a 30-year mortgage was 3.51%. With interest rates under 5.00% over the past couple of years, many of us have forgotten that rates were in the double digits between 1979 and 1990. In fact, looking at data tracked by the Federal Reserve, the average interest rate over the past 30 years was 7.92%.
If we compare a $100,000 mortgage at that rate compared with current rates, you will see that today’s rate results in a savings of $100,293 in interest paid over the life of the loan (see Exhibit 1). This number is staggering, as the borrower at the higher interest rate essentially pays an extra mortgage to the bank.
However, many homeowners are not taking advantage of this opportunity due to the hassle of the application process. Over the past couple of years, lenders have tightened their underwriting standards, which left many borrowers frustrated. Applying for a loan does not need to be complicated and can be a very straightforward process with a basic understanding of how a lender evaluates a loan and what documentation will be required.
In reviewing every loan, a lender will look at three categories of information commonly referred to as the “3 C’s”:
Collateral – what is the property and its value?
Credit – do you have a clean history of paying back your loans and other obligations? Do you have bankruptcies, judgments or foreclosures?
Cash Flow – is your annual income sufficient to cover your debt? Typically, lenders will require that your mortgage payment be 28% or less of your income and that your total debt payments be no greater than 36% of your income.
If you are planning to refinance, start a file that contains all of the information you will need to document your income and assets. This includes information such as:
- 3 years of tax returns
- 3 months of bank and brokerage account statements
- your credit report
- paystubs for the past 30 days
- documentation of any other assets such as retirement accounts
Starting the refinance process armed with the knowledge of how lenders look at your loan and what information they need to review your file will put you in the driver’s seat of your financial future.