Solving refinance challenges |
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Problem: inadequate income or excessive debt
Income and debt are two sides of the same coin because lenders use both factors to calculate your debt-to-income, or DTI ratio. This ratio is important because lenders want to feel confident that you earn enough income to keep up your mortgage payments. If you've suffered a loss of income, overstated your income on your original loan application, are self-employed or have taken on additional new debts, you're most likely to be among the many homeowners who face this type of problem.
The DTI ratio is essentially "about affordability," Satrick says, "Either they can afford it or they can't." If you're in the latter group, you might be able to obtain relief through a loan modification instead of a refinance.
Lenders typically look for a DTI ratio that's no more than 38 percent, your debt is no more than 38 percent of your income. However, DTI is a complicated issue and 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 through a better-paying job, pay raise or second job. Your second job 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, Thompson says.
If you can qualify for an FHA-insured loan, you might be able to add a nonoccupant co-signer to your loan application, Thompson adds. Be aware that the cosigner's debts, as well as his or her income, will be counted along with yours.
Another option may be to document additional sources of income. Rents, annual bonuses, limited partnership payouts and the like can strengthen your DTI ratio, if you're "willing to go through the challenge of explaining and documenting" that income, Linnane says.
"I would encourage people to consider that what they may think might be impossible to explain or difficult to explain maybe wouldn't be so impossible or difficult," he says.
On the flip side, paying off debts also can be a good strategy to refinance, even if savings are sacrificed to the cause.
"Maybe you owe $5,000 on a car loan, and you have $6,000 of discretionary cash in the bank. In this case, you could pay off the car loan to eliminate that payment and eliminate the problem," Linnane says.
Some borrowers may want to focus on short-term installment loans, which have a fixed term, because some lenders will exclude an installment loan that has fewer than 10 payments remaining from the DTI ratio, Thompson says.
Problem: credit score is too low
Your credit score is a function of your credit history, which tracks how well you've handled your financial obligations. Lenders are concerned about your credit score because they want to make sure you're 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," Thompson says.
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 factually erroneous information in your credit report that may adversely affect your score. Neither solution is a quick fix, but as Thompson says, "you can change a lot in six months."
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