Solving Refinance Challenges
1-22-09 Homeowners with financial trouble who want to refinance their mortgages are happy to know there are still options out there for them. There are ways to overcome challenges such as income, debt, negative equity and/or poor credit.
The challenges are real. Lenders have indeed tightened their guidelines and there are fewer solutions to common problems.
Problem: inadequate or negative equity
The most common problem is a lack of equity due to declining values. Lenders use equity as a component of your loan-to-value, or LTV, ratio. If your original loan was at or more than 80% of the value of your home, then this now may be a problem for you. The typical LTV ratio most lenders require today is 80 percent, though there may be some flexibility in that figure.
Solution: Reduce 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 or partial payments. If you can add $300, $400 or $500 per month toward your principal over time, that is lowering your principal and the interest that’s being charged on your outstanding balance….. so you are paying off the loan even faster.
If your mortgage is insured by the Federal Housing Administration (FHA), you might be able to qualify for a “streamlined” refinance. More information about this program can be found on the U.S. Department of Urban Development’s web site.
If you have a second loan, you might want to combine both of your loans into one new loan. If you obtained your second loan through the same lender as your first , you may be in a better position to combine the two loans than if you obtained your second loan from another lender. In that case, you’ll be subject to more strict guidelines because your refinance will be considered a cash-out, rather than a conventional rate-and-term refinance. Regardless, this strategy may be a better option since your total monthly payments will most likely be lower.
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 know that you earn enough income to make your mortgage payments. Lenders typically look for a DTI ratio that is no more than 38 percent (your debt is no more than 38 percent of your income); however some lenders’ 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 troublesome DTI ratio is to earn more income . If you secure a second job, then it must be a stable permanent position since most lenders require a two-year track record before they’ll count that income toward your DTI ratio.
Problem: credit score is too low
Your credit score is directly related to your credit history. 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 grant such leeway to credit-impaired borrowers today. You may be offered financing, but the interest rate likely won’t be “low enough to make it attractive to refinance.
Solution: Pay bills on time
There are two ways to overcome a poor credit score. One is to improve your score over time. The other is to challenge any incorrect information in your credit report that may adversely affect your score. Neither solution is a quick fix, but you can change a lot in a few months.