Tighter lending standards have made refinancing a home more difficult, even for some well qualified borrowers.

You’ll want to be familiar with these standards before you make any life changes; such as a change in career, or a move to a new community.

Why is it important to understand what it would take to qualify before you try to refinance a home? Here’s one way it could catch you off guard:

Bob had worked his whole life in corporate America. He took an early buy out package and began his own consulting business.

He and his wife owned several rental properties in addition to their home. To fund the start up costs of his new business, he had planned to refinance a home or two, but he just didn’t get around to it before he left his corporate job.

Bob didn’t realize that qualifying for a mortgage as a self-employed person was much different than qualifying when you had a salary. Without two years of documented income in his new line of work, he was gong to have to pay a higher interest rate than he had anticipated. Refinancing a home no longer made sense for him.

Don’t let yourself get caught off guard. If you meet all of the following criteria, than when it comes time to refinance a home, you’re probably in good shape:

  • 20% equity in your home
  • Credit score over 600
  • Loan amount less than $417,000
  • Two years of documented income (via tax returns if self employed. W-2 income if you work as an employee.)
  • Total debt payments, not including the mortgage, are less than 33% of gross income
  • Total debt payments, including the mortgage, are less than 45% of gross income

You still need to be cautious: changes in the way lenders value property may mean you have less equity than you think.

Below are the three major changes in mortgage lending that you need to know about before you refinance a home:

Conservative Valuations /Appraisals

Part of the appraisal process involves looking at comparable properties or “comps”: other properties like yours that have been recently listed or sold. This helps the lender determine the current market value of your home.

What’s different now?

More distressed properties: It used to be that if a property under foreclosure showed up in your comps, you were allowed to throw it out. Not today. There are too many bank owned properties on the market. Their lower listing and sales prices will affect the appraised value of your home.

Declining markets: If the lender determines you live in an area determined to be a “declining market’ they can decide to reduce the appraised value of your home by an additional 5 – 10%. This means even if your appraisal shows you have 20% equity in your home, the lender may not accept that.

No Market for Second Mortgages: Means More Money Down or Higher Monthly Payments

Private mortgage insurance (PMI), has always been required for borrowers with less than 20% equity in their home. Its purpose: to protect the lending industry against defaults. The cost of this insurance was added on to the buyer’s monthly payment.

Aggressive lending tactics allowed many buyers to bypass this cost by using a second mortgage. For example, if they were refinancing to get a lower interest rate or take equity out, they could take a first mortgage for 80% and a second mortgage for 10%.

The ability to structure this type of loan has all but disappeared. Lenders are no longer willing to take this risk.

If you have less than 20% equity in your home, expect to pay for PMI insurance.

Some home equity lines of credit will allow you to take up to 75% of your home’s value (using conservative valuation criteria), but you’ll be hard pressed to find anyone willing to lend more than that.

One borrower, faced with rising interest rates and a rising house payment, had a mortgage broker help her find a creative solution.

Solution to a Refinance Problem

Bruce Young, a Mortgage Banker with People’s Mortgage, was working with a credit challenged borrower who had taken a subprime loan a few years ago, as it was the only option she qualified for at the time. The loan was now adjusting with highly unfavorable terms that pushed the new payment higher than was affordable for her.

Due to declining real estate values, she no longer had 20% equity in her home. Due to the lack of equity in her home, lenders were not willing to refinance her home unless she could come up with some cash to contribute at closing.

The solution: she borrowed money out of her 401k plan in order to put the required amount of equity in to qualify for her refinance.

The net savings in her monthly mortgage payment was enough to allow her to set up a repayment schedule for the 401k loan and remain in her home.

Must Have Documented Income

Stated income loans allow borrowers to omit or reduce some of the documentation that conventional loans normally require. For those who are self employed, or recently started a small business, this means they can refinance a home without having to show W-2’s and/or two years worth of tax returns.

While stated income loans are still possible, expect to pay a rate of 1.5% - 3% higher than those who can document their source and stability of income. In addition, you must have better credit scores and higher loan to value ratios than required for conventional loans.

If you are planning on leaving a corporate job, look in to purchase or refinance options while you can still document your income. Once you’ve got the loan they can’t come back and ask you to re-qualify.



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