Homeowners wanting to refinance their mortgages to better rates should be happy to hear there are still options out there for them. There are strategies available to help overcome challenges such as inadequate income, excessive debt, negative equity or poor credit. These challenges are legitimate. Lenders have tightened their guidelines, and there are few good solutions to common problems.
Problem: inadequate or negative equity
The most common problem is a lack of equity, which lenders measure as a component of your loan to value (LTV) ratio. If you refinanced your original mortgage to take out cash, bought your home without a down payment, obtained an interest only or payment option mortgage, or if your property has declined significantly in value, you may be likely to encounter this problem.
The typical LTV ratio most lenders require today is 80 percent. However, there may be some flexibility in that figure, and some government loan programs are more generous.
Solution: reduction of principal
One strategy to overcome this problem is to lower your loan amount, so your LTV will fall within the guidelines.
That can be accomplished through a lump sum payment,a gradual reduction of principal or a combination of both. A lump sum can be applied from a savings or retirement account, sale of another asset, income tax refund or bonus while a gradual reduction in principal can be achieved by making larger or additional payments.
Those additional payments not only lower your principal balance but they also reduce the amount of interest you pay on your loan.
If your mortgage is insured by the Federal Housing Administration or FHA, you might be able to qualify for a streamlined refinance that doesn’t require an appraisal. More information about this program can be found on the U.S. Department of Urban Development’s web site.
Mortgage insurance, which protects the lender from loss if you default on your loan, also may be a way to overcome insufficient equity. However, you will have to pay mortgage insurance premiums and that could impact the benefits of the refinance. You will need to do the calculate whether this makes sense for you.
If you have a second loan you may want to combine both of your loans into one new loan. If you obtained your second loan through the same lender as your first and as part of your original financing, you may be in a better position to combine the two loans than if you obtained your second loan later on. This strategy may be the best option for many people.
Problem: inadequate income or excessive debt
Income and debt are related because lenders use both factors to calculate your debt to income (DTI) ratio. This ratio is important because lenders want to feel cocomfortable that you earn enough income to keep up your mortgage payments. If you lost income, overstated your income on your original loan application, are self employed or have taken on new debts, you are most likely to be someone who faces this type of problem.
Lenders typically look for a DTI ratio that is no more than 38% of your gross monthly income. However, DTI guidelines vary, so it’s a good idea to discuss your situation with a loan officer.
Solution: Earn more, pay off debt
The most obvious solution to a problem DTI ratio is to earn more income either from an increase in pay with your existing job or a second job.
If you can qualify for an FHA loan, you might be able to add a cosigner to your loan application. Although this is an option, it can cause problems down the road between borrower and co-borrower.
Another option may be to document additional sources of income such as rents and annual bonuses
Problem: Credit score is too low
Your credit score is based upon your credit history, which tracks how well you handled your financial obligations. Lenders are concerned about your credit score because they want to make sure you are financially responsible enough to repay your loan. While a poor credit history was often overlooked when home prices were on the rise, lenders rarely look past credit scores today. You may be offered financing, but the interest rate likely will not be low enough to make refinancing worth the trouble.
Solution: Pay bills on time
There are two ways to improve a poor credit score. One is to improve your score over time by making payments on time. The other is to challenge any incorrect data in your credit report that may adversely affect your score.