Low mortgage rates have made refinancing an attractive proposition for homeowners who want to cut their monthly payment, extend their term or restructure their housing debt. Yet there are hurdles that can make refinancing difficult. Here are three of the most common refinance hurdles and ways to overcome them.
Hurdle no. 1: Your LTV is too highYour loan-to-value ratio, or LTV, is your loan amount expressed as a percentage of your home's current value. For example, if you want to borrow $80,000 and your home is worth $100,000, your LTV is $80,000 divided by $100,000 or 80 percent. A higher LTV won't preclude refinancing, but you'll probably have to purchase mortgage insurance, which protects the lender's interest if you default on your loan. Jump: If your LTV is on the high side, one option to consider might be the Home Affordable Refinance Program, or HARP, which "allows certain borrowers who have loans that are owned or guaranteed by Fannie Mae or Freddie Mac to refinance without regard to the loan-to-value ratio," explains Joe Parsons, senior loan officer at PFS Funding, a mortgage company in Dublin, Calif. One catch, according to Kirk Chivas, chief operating officer at First Commerce Financial in Wixom, Mich., is that your loan must have been originated on or before May 31, 2009, to refinance through HARP. Two other high-LTV options might be the FHA Streamline Refinance program, if your loan is insured by the Federal Housing Administration, or a loan guaranteed by the U.S. Department of Veterans Affairs, if you qualify for that. Given its 100 percent financing, no mortgage insurance and flexible qualification guidelines, Parsons describes the VA loan as "the best loan on the planet, by far." A completely different option would be to lower your LTV by paying off a chunk of your mortgage. This approach is known as a cash-in refinance.
Hurdle no. 2: Your DTI is too highYour debt-to-income ratio, or DTI, measures your capacity to pay your debts. For example, if your monthly income is $4,000 and your monthly minimum payments on your credit cards and other non-housing loans total $800, your DTI is $800 divided by $4,000 or 20 percent.
Lenders' DTI guidelines can be somewhat flexible, but if you're carrying a high debt load relative to your earnings, your DTI might be a barrier to refinancing.Jump: To lower your DTI, you'll need to earn more money or pay off some of your debts. Oftentimes, however, neither of those approaches is realistic. "Typically, there's no solution," Chivas says. "People have gotten themselves in this position due to poor decision-making or a job loss of one or two people working in the household."
Hurdle no. 3: Your credit score is too lowA third common hurdle to refinancing is impaired credit, according to Joe Metzler, a mortgage specialist at Mortgages Unlimited in St. Paul, Minn. "A standard conventional-type loan requires a (credit score of) 660 or higher to be in the game," Metzler explains. "With an FHA loan, 100 percent of lenders will work with you if you have a (score of) 640 of higher. As soon as you drop to 639, you drop to 25 percent of lenders. Once you drop below 620, you drop to less than 10 percent of lenders. Below 600, you drop to 2 percent of lenders." Those scores and percentages are approximations, yet the correlation is clear: the lower your score, the fewer lenders might approve your loan. "You're going to hear a lot of no's before you find a yes," Metzler says. Moreover, that yes will be expensive due to so-called price adjustments that lenders apply to loans they deem more risky. Parsons says the adjustment might be as much as 3 percent of the loan amount, or about three-quarters of a percent on the rate, for a score in the 620 to639 range. Jump: To avoid a price adjustment, you'll have to boost your credit score by using credit more responsibly. Parsons says it's also worth the effort to try to negotiate with your creditors or collection agencies if you have past-due balances or delinquent accounts. Ask for what's called a deletion letter, which says your account has been paid in full and the negative item should be removed from your credit history.
While each of these hurdles can be a high obstacle to clear, the right loan product and financial planning can help you achieve your goal of refinancing your mortgage.