Here’s a common situation: you old mortgage has an interest rate that is quite a lot higher than today’s available rates, and you could save hundreds of dollars each month by refinancing. You have lots of equity in your home now that the market has recovered nicely. There’s one problem: you don’t have enough income to qualify for the loan you need.
Why can’t I refinance when it will actually make my expenses go down?
Lenders look at an important number called Debt To Income ration, or DTI. They calculate this by adding up the total house payment (including taxes and insurance) and all other debt (credit cards, student loans, car loans, etc.). They divide that total debt number by the borrower’s gross monthly income to arrive at DTI. It can’t exceed 45%.
There are many ways the DTI can get too high: a family that had two incomes when they applied for the original loan may now have just one, there could be more debt in the picture for any number of reasons—or a combination of the two.
Keep in mind that it doesn’t matter how flawless your credit is; if your DTI is over 45% (even 45.01%), you won’t get the loan.
If your DTI is too high, running out and getting a second job won’t do the trick; in order for income from a second job to count, you have to have it for at least two years. So we have to look at the debt side of the equation to solve the problem.
How to solve the DTI problem
There are two common ways to get the DTI down.
- If we are just a tiny bit too high, it may be possible to “buy down” the rate. This means adding one or more points to the loan to drop the rate (one point is 1% of the loan amount). Each point will reduce the rate by about .25%. Dropping the rate .25% on a $300,000 loan will reduce the payment by about $40 per month. This may be enough to do the trick.
- If you have any consumer debt showing on your application, paying off some or all of it will improve your DTI, too. Paying off a $5,000 credit card will reduce your monthly debt payments for qualifying purposes by $150.00. Please keep in mind, though, that while paying off a $5,000 credit card using home equity can be a good strategy, it does you no good if you let the account balance climb again. You should also make plans to pay a little extra on your monthly payment each month to avoid having to take 30 years to pay off a credit card or car.
One other possibility that may work for you if your DTI is too high: see if you are due for a raise. Really, I’m not kidding. If it has been a year or more since your last increase, you may be overdue. Just make sure that your HR department is prepared to show your new rate of pay on the Verification Of Employment form that we will send them.
Here is the real message that you should take from this: just because your loan refinance situation may look somewhat hopeless today doesn’t meant that we can’t work together to find solutions. Not all of the solutions are obvious, but a little creative thought and brainstorming can often come up with the solution you are looking for.
If you want to see what else you can do to get the most from a mortgage refinance, download our free ebook by clicking the button below.