Your Guide to Mortgages
Whether you are a first-time homeowner or looking to refinance an existing mortgage, you probably still have plenty of questions about the process. Consider the following: What is the best kind of loan for me? What are the qualification requirements? What are my rights as a homeowner? How do I find the right lender for me? How do I know whether my lender was telling me the truth? Are there any tricks to getting the best deal?
Borrowers typically choose to refinance an existing mortgage in hope of receiving a loan that better meets their needs. People may pursue this option for any number of reasons: drastic changes in income, real estate market fluctuations, or economic shifts. The most common reason homeowners refinance their existing mortgage is to get a loan with a lower interest rate. By refinancing your home in an effort to get a lower interest rate, you also lower your monthly payments and ensure you will spend less over the lifetime of the loan.
Here is an example of the difference in monthly payments for a homeowner with a $300,000 mortgage who refinances to a lower rate.
While getting a lower interest rate is certainly the most common motivator for homeowners to refinance, the lowest interest rate may not always be the best choice for everyone. In some cases, loans with higher rates but fewer (or no) costs can end up benefiting you more than one with a lower interest rate. Besides the interest rate, there are plenty of other reasons to refinance your home.
Top 5 Reasons to Refinance
Refinancing can allow you to either extend or shorten the term on your loan. This will depend upon your individual budget.
Refinancing is an excellent way to reduce or eliminate your mortgage insurance premium. In fact, mortgages newer than April 1, 2013 can only have their MIP canceled via refinancing.
Refinancing can allow you to access a lower rate, which will significantly reduce your monthly mortgage payments.
Cash-out refinancing offers homeowners the opportunity to tap into some of their house’s equity.
In the case of divorce, mortgage refinancing allows one spouse to buy out the other’s interest. This effectively severs the jointly owned property and allows for a simpler allocation of cost.
Prepare Yourself for Rate Drops
To get the best rate, you should analyze rates regularly and watch for drops. Falling refinancing rates are often publicly talked about in the news, which often leads to a major uptick in applicants. Waiting for refinancing to become a hot topic can mean risking higher numbers of applicants, meaning your refinancing application will take longer and cost more. s Fortunately, you can prepare for rate drops and stay ahead of other applicants.
Firstly, learn more about your target rate. Determine what interest rate would be ideal for you, then compare that to current refinance rates. If you run the numbers through a refinance calculator and find that the savings will cover loan costs quickly, then you have found your target rate. If not, run the numbers using a lower interest rate. Running the numbers until you find that the savings will cover the costs can help you better identify when you should pull the trigger and refinance.
Second, pre-approval for refinancing can help you quickly refinance when the time is right. Without pre-approval, you may risk small errors or unexpected problems delaying the process.
How Homeowners Miss the Refinancing Boom
Refinancing booms occur during significant mortgage rate drops. In these instances, rates drop to the point that a large number of homeowners may meet their target rate and take the plunge to refinance. There have been several of these refinance booms since the early 1990s.
In 2012, a Federal Reserve study showed that many homeowners did not capitalize on these refinance booms. The reason for this was simple: homeowners forgot or neglected to watch interest rate trends and missed the point at which they would have met their target rate. Other homeowners reported feeling that the refinance savings were too good to be true and did not believe they could qualify for such a loan. Other homeowners seemed daunted by the task of completing the necessary paperwork. This decision turned out to be quite a costly one. According to the Federal Reserve, those homeowners in 2013 that neglected to take advantage of refinancing offers could have saved $26,400 over the lifetime of their loans.
Though the last finance boom may have come and gone, you may still be able to save. Rates rise and drop regularly, and the resulting mini-booms can help you save money if you are prepared for them.
For homeowners who did not refinance in 2015, now would be the time to look at a few mortgage quotes, and prepare your paperwork: Credit score, home value, and current loan balance. Spending a few minutes with a refinance calculator can help you see how much you might save, which can help you to hold your own in a future conversation with a lender. Once you have your information in order, you can contact some lenders and begin applications refinancing. Since most lenders utilize automated underwriting systems to fill out and complete refinance applications, pre-approval can take mere minutes.
Your lender will give you the information you need and help you identify which documents are required to complete your loan. Most common requirements include two years of W-2s, recent paychecks or pay stubs, tax returns, and copies of bank, retirement, and investment statements. If you are approved, you will be able to lock in your loan the moment rates drop into your target zone. With a couple of hours of work compiling paperwork, you can save thousands of dollars a year. How often does the opportunity to earn thousands of dollars in a few hours come around?
Refinancing: The Basic Requirements
Many homeowners do not even consider refinancing their mortgages because they don’t believe they will qualify. Despite these worries, around 40% of homeowners who have not refinanced could have qualified to do so, and around half of those could have saved significantly on their refinanced mortgage. While it may sound outlandish, millions of people are overpaying for their mortgages month after month, year after year, despite qualifying for significant savings.
The fear for many homeowners is that they will put in the effort to apply only to be turned down. Though this fear is understandable, many homeowners will find that they meet more qualifications than they realized if they only do a little research. If you are feeling hesitant about applying for refinancing, take a look at this list of qualifications and see how many you meet.
Refinance & Credit Score
Here are details from Fannie and Freddie, which back most non-government loans on what minimum credit qualifications and payment history you must meet in order to be approved for refinancing:
- Minimum Credit Score: 620, unless the applicant has no credit score.
- Individuals who have filed Chapter 13 bankruptcy must complete a two-year minimum waiting period before refinancing.
- Individuals who have filed a Chapter 7 bankruptcy must complete a four-year minimum waiting period before refinancing. In the case of applicants who can provide documented evidence that their bankruptcy was caused by outside/uncontrollable factors (such as wage earner death) may be granted only a two-year waiting period.
- In the case of foreclosures, short sales, and deeds-in-lieu of foreclosure range from two to four years. These decisions are made on a case to case basis.
- Applicants with mortgage payments that are more than 60 days late within a 12 month period are rarely accepted.
- All outstanding judgments and collections must be repaid at or before closing.
Homeowners with less than 20% home equity may also be subject to credit score minimum requirements from private mortgage insurers, which can be significantly higher than the minimums established by Fannie and Freddie.
Government-backed mortgages tend to be less stringent and have fewer scoring guidelines. For example, the U.S. Department of Veterans Affairs does not list a minimum credit score. The FHA lists their minimum credit scores at 500 for a 90% loan, and 580 for 96.5% loan.
While lower credit scores may be acceptable by some loaners, poor payment history is rarely acceptable. Lenders rarely if ever approve loans to those applicants who have an established history of missed or late payments, regardless of having the necessary income. If you have a history of missed payments, there is no need to fear in the long run. A year or two of good payment history will help you reestablish your credit in most cases.
It should be noted that not all mortgages are backed by the government or sold to investors. Guidelines for private or individual lenders can and often do vary from those listed above.
Mortgage Refinance & Income
A recent change in mortgage reform has to do with lenders setting reasonable limits, the Ability to Repay rule in other words. This rule was put in place by the Consumer Financial Protection Bureau and requires mortgage lenders to “make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling.” This policy essentially asks that lenders limit the borrower’s debt-to-income ratio to 43% or less.
The rules for streamline refinancing differ slightly from other methods of refinancing. Streamline refinancing replaces one government-backed loan with the same kind of loan (i.e. FHA to FHA.) Streamline refinancing is a great way to reduce or remove the risk of default by helping to improve the borrower’s financial situation. Streamlining can eliminate the need for credit score information, appraisals, and income/employment verification. Similarly, homeowners who are eligible under the Home Affordable Refinance Program may have the opportunity to refinance despite poor credit or low income.
Refinancing: When It Hurts You
Though refinancing your existing mortgage can help lower your monthly payments and interest rate, refinancing may also cost you more in the long run. Refinancing a five-year-old 30-year mortgage with a new 30-year mortgage means you are now paying a 35-year mortgage. Even with lower interest rates or monthly payments, this can mean paying off an extra 5 years of interest that otherwise could have been avoided. Now imagine you refinance again in 5 years, your 30-year mortgage has just become a 40-year one.
Extension on the Life of the Loan
While refinancing can save you money, many misinformed loan officers and lackluster refinance calculators often neglect to note the fact that refinancing restarts the homeowner’s loan payment clock, which often results in overestimating the benefits of refinancing.
Let’s say for example you have a $300,000 mortgage with a 4.25% interest rate, making its balance after 5 years $272,423. Refinancing this loan with a new 30-year loan with the same rate of 4.25% will lower your payment by $136. Though some lenders and calculators may refer to this difference as ‘savings’ the truth is that there are no savings at all. Even without upfront costs or refinance costs, this refinance would increase the loan by $39,711 and add 5 years to the repayment period.
Now let us take a look at what happens when you refinance a 5-year-old loan to a lower rate without taking the extended repayment into consideration.
Though refinancing into a new 30-year mortgage will significantly lower your interest rate and payments, by the time the new loan has reached the end of the payment period you will have paid $11,442 more than if you did not refinance initially. Making higher payments and retiring the loan five years earlier with a 25-year mortgage will turn that $11,442 into $22,562 in savings, while also reducing your monthly payments to $75 a month. Though you did not extend the repayment term, this is where you find true savings.
Refinancing: The No-Brainer
If you can reduce your interest rate at no cost, or you will be able to recoup the refinancing fees prior to selling your home, then the decision to refinance is a no-brainer. However, these savings are guaranteed only if you do not extend your repayment period. Refinancing with a shorter term or paying a small amount extra every month, you can benefit from a lower interest rate without extending your repayment period. If this is the route you choose, your loan officer will help you calculate how much to pay, or you may be able to work it out with a mortgage prepayment.
Refinancing: I Don’t Think I Qualify
Everyone wants to save money, especially when it comes to high monthly mortgages. Mortgages interest rates are low, and you may be considering refinancing your mortgage to cut your bills, or maybe you are thinking about refinancing because you’re afraid of the unpredictable interest rates. Mortgage refinancing allows you to tinker with the mortgage repayment period. This means you can choose to lengthen your loan or shorten it to repay it faster.
Although refinancing your mortgage may seem attractive, it won’t make any sense if the numbers don’t add up. Always ensure that the current interest rate is anywhere near a half percent lower than your current mortgage interest rate. For instance, in case you have $390,000 remaining on a $400,000 loan at an interest rate of $4.25 percent, replacing your mortgage at a rate of 3.75 percent means you can save up to $162 per month.
Regardless of why you want to refinance your mortgage, in the back of your mind, you may be holding back from applying because you are uncertain whether you qualify for a refinance or not. One of the common misconceptions amongst most homeowners is that credit score is always king, and that is the main determining factor for a mortgage refinance approval.
While credit score matters, it’s not the only factor that lenders will consider. If you have a poor credit score, don’t assume that you are out of options. Having a less-than-perfect credit score may bar you from enjoying low-interest rates, but you can qualify for a mortgage refinance even if you have previously filed for bankruptcy. Below are a few examples of homeowners who thought they couldn’t get their mortgage refinance application approved, but they were able to overcome all barriers.
Refinancing: My Income Is Too Low
Richard M. of Miami, Florida was worried he would never be able to refinance. “I’m retired,” he said, “and my income is much lower now, about half of what it used to be. I bought my house when I was working, and I barely qualified then.” Besides his reduced income, Richard had one more hurdle to overcome: the Consumer Financial Protection Bureau and its Ability to Repay rule. This rule means that even borrowers who can afford to pay a loan may not qualify if they cannot prove their income with documentation.
Lucky for Richard, his loan officer was able to find a few things that worked in his favor. Everything Richard’s loan officer did was in order to improve his “paper income.” First, she grossed up Richard’s Social Security Income. She was able to do this because it is not taxed, and most underwriting guidelines allow lenders to increase untaxed income by 25%. This simple trick turned Richard’s $3,000-a-month Social Security income into $3,750.
Second, Richard’s loan officer explained to Richard that under the new guidelines, he could report his savings as income. This process is referred to as “asset depletion” and works like this: underwriters take 70% of eligible assets and divide them by the number of months in the loan term. In Richard’s case, he had just over $700,000 invested. 70% of that provided $490,000 in assets to deplete. Richard’s loan officer then divided $490,000 by 360, which added $1,361-per-month to Richard’s income.
With these two simple tricks, Richard’s loan officer was able to increase his ‘paper income’ by over $2,000 a month. With this added income, Richard was able to qualify for and receive his refinance.
Refinancing: I Can’t Because I Just Changed Jobs
Chandler and Emily K. from Dallas, Texas were worried they wouldn’t be able to refinance because Chandler had just gotten a new job. “I read that you have to be on your job for two years before you can get a mortgage,” Emily said, “and Chandler just started this one two months ago.” Emily and Chandler aren’t alone; it is a common misconception that borrowers require two years at their present job in order to qualify for a mortgage. This is likely due to the Fannie Mae Form 1003, a mortgage application form that requires applicants to show their job history within the past two years.
While self-employed and commissioned applicants do need at least two years worth of work history to show their lender that their income is stable, there is no minimum requirement for borrowers’ current employment. In fact, this rule is such a misconception that Fannie Mae’s Guide clearly states “Individuals who change jobs frequently, but who are nevertheless able to earn consistent and predictable income, are also considered to have a reliable flow of income for qualifying purposes.”
The two-year rule is so irrelevant that plenty of borrowers can receive mortgage approval simply based on promised income stated in a job offer letter. The only considerations that truly matter are as follows:
- Applicant’s work history shows increasing responsibility and earnings.
- The borrower is financially strong enough despite frequent job changes.
Fannie Mae specifies that “if the job changes are for advancement or higher wages, these changes should be viewed favorably.” A borrower with a long job history that indicates a variety of positions and income increases will be viewed favorably, just as an applicant with a short history due to college or job-training can also be viewed favorably.
Applicants with a series of short-lived working stints in a variety of industries tend to be the exception. Fannie Mae’s Correspondent Lending Guidelines say, “Evaluation of history of employment, ability to generate similar income consistently, number of years in the same field of work, specific educational background and sources of any additional compensation must indicate the income can be expected to continue.”
When it comes right down to it, Chandler’s new job turned out to be in the same field as his previous one and offered a higher salary. He and Emily had no trouble refinancing and got a better loan.
Mortgage & Home Equity Refinance
Home equity refers to the value of a property and the amount of loans against it.
In the above example, we show a starting appraised value of $200,000, then subtract the home loan balance of $150,000, arriving at the owner’s equity which is, in this case, $50,000. Home equity can also be referred to as loan-to-value (LTV). To calculate the LTV, take 100% minutes the percentage of home equity. In the example above, the homeowner has 25% home equity, putting LTV at 75%.
Calculating Your LTV
By simply dividing the refinance loan amount by your home’s estimated value, you can calculate your LTV.
When researching and requesting mortgage rates from lenders, you will need to provide them with a reasonable estimate of your home’s value. Claiming a value of $200,000 when the actual value is $180,000 will result in a higher LTV. This can cause your overall mortgage rate to increase, or your loan to be denied altogether.
The Home Appraisal
When a lender orders a home appraisal, it is to create an independent estimate of the worth of the property. Here are the things that will be analyzed during an appraisal:
- Surrounding property prices
- Supply and demand for homes in your area
- Trends in price movement, either increasing or decreasing
- Overall condition of the home as compared to other homes in the area
- Size of home and lot
- Any hazardous or questionable conditions that may affect the livability or marketability of the home
Despite appraisals being conducted according to this set of rules, appraisals from different lenders will rarely be the same. Appraisals by private lenders are often quite subjective. Some lenders may also rely on automated valuation models, which are the tools used to examine recent sale prices in your area. Appraisals conducted by automated valuation models rarely include an in-person home visit. While AVMs are one of the fastest and least expensive options for mortgage approval, an AVM cannot see the $100,000 worth of remodeling you have done to your home in order to increase its value. In these cases, many homeowners prefer a visit from an appraiser in order to more accurately estimate the actual value of your home and property.
Refinancing: Avoiding a Low Appraisal
Though appraisals do involve a certain amount of subjectivity, there are a few simple steps you can take to get an accurate and generous appraisal. First, ensure your home is inviting, clean, well maintained, and smells good at the time of your appraisal. First impressions and the general atmosphere of your home can help get you a more generous appraisal.
Second, provide an accurate layout of your home’s plans, as well as any improvements that have been made and the cost of those improvements. Ensuring these plans are accurate is integral to the success of your appraisal. According to the National Association of Realtors, errors often occur in floor plans or dimensions, which can easily result in a lower appraisal than expected.
Inaccuracies in paperwork aren’t the only cause of undervalued appraisals. Thanks to a reform called the Home Valuation Code of Conduct, lenders are unable to select appraisers. Because of this, there has been an uptick in appraisals being conducted by underqualified appraisers or those who may not be best suited to the particular job. This has lead to a significant increase in undervalued appraisals.
Luckily, there are ways to avoid getting stuck with inexperienced appraisers. Homeowners can check with their lender to find out when their appraisal will take place, and get the name of the appraiser. Given enough time, homeowners can look up the name of their appraiser, determine their expertise, find out how long they have been licensed, whether they have experience in your area, and determine whether or not they will be a good fit. In some cases, given enough time, you may be able to ask for an alternate appraiser.
Refinancing: Disputing a Low Appraisal
In the event that your appraisal comes in surprisingly low, you may be able to request a reversal if the low appraisal is due to an objective error. Wrong square footage or sales price can, for example, show that the valuation of your home was incorrect. In most cases, once the appraisal has been made, the homeowner will not be able to change the resulting valuation by arguing for that they view their home as worth more than its appraised worth.
Should you choose to dispute a low appraisal, there are right and wrong ways to do so. You should start by downloading a form to make it easier for the appraiser to make the revisions. Appraisers tend to work under tight time constraints, meaning they tend to be unwilling to change or revisit appraisals once they are complete. Complete this form created by an appraiser, and forward it to your loan officer. Your loan officer can then pass it on to the appraiser or underwriting department for consideration.
The next solution is simply to order a second appraisal. Many homeowners are hesitant to do this because it means additional fees and stress but can be worth it to receive a higher appraisal valuation. If you choose to go this route, ask your loan officer to not submit your original low appraisal value. Request a new one and be sure to do your research on your new appraiser to ensure you don’t get stuck with the same issue again. Often times, if the second appraisal comes in higher, your lender will be willing to consider it for refinancing approval. If your second valuation comes in low, you may need to face facts and understand that your property is worth less than you initially believed.
Lastly, if you are convinced and certain that your home is worth more than the appraisal value, you can always begin the application process over again with a different lender. This will allow you to utilize a different appraisal service, and hopefully, avoid low-ball estimates.
Is Refinancing Possible With Bad Credit?
Refinancing with bad credit, while more difficult, is not impossible. Loans are approved based on the entire application, not one singular element. Refinance underwriters look at income, home equity, assets, payment history, and more, in addition to credit score. A low credit score can be offset or made irrelevant by higher equity, excellent income, and excellent payment history.
Though it is possible to get a loan with bad credit, it has become more difficult over time. The majority of lender programs cite minimum credit score requirements, and individual lenders often have even stricter policies for their applicants. The best advice we can give to the homeowner with bad credit is to work to improve their scores and investigate a variety of mortgage lenders. Spending a few years to improve your credit score even by a few points can mean the difference between denial and approval.
Government-backed loans tend to be more forgiving than private or conventional loan programs. Homeowners with low credit scores should consider an FHA streamline refinance if their current mortgage is government-backed, as streamline programs do not require credit underwriting.
Refinancing for Other Reasons
Other than finding a lower interest rate or improving the cost of monthly payments, a common reason people refinance is in the event of a couple splitting, or to get rid of mortgage insurance.
Keeping Your House After a Divorce
Even after a divorce, both parties whose names are signed to the loan remain obligated to make mortgage payments. In these situations, the easiest and least stressful option is to refinance under only one name, the name of the party that will remain in the house.
Divorce & FHA Streamline Loans
Homeowners with FHA loans can streamline the process of removing one party from the loan. The FHA streamline program allows for the loan and property to be transferred to the remaining-occupant if the transfer occurred more than six months previously. If during this time the remaining-occupant can show that they are able to make the mortgage payments independently, you may qualify for an FHA refinance after your divorce.
Divorce & Conventional Loans
For homeowners with conventional loans, the process of refinancing requires proof of income and the ability to cover all payments and other obligations without the help of the other homeowner. In these cases, the remaining occupant will be required to show further proof of income and stability in order to refinance.
If Refinancing Isn't an Option For You or Your Ex-Spouse
In some recent divorce cases, divorced individuals do not qualify for refinancing due to a lack of property equity, low income, or poor credit score.
When There Are Limited Good Options
Though a situation in which one or both ex-spouses cannot afford to refinance has few good options for resolution, there are a few ways to handle the situation. The first option is to ask the non-occupying party to agree to a refinance extension. This process will need to be put in writing and filed with the court. You may also ask for an assumption from your lender, though it should be noted that they are not obligated to do so unless assumptions were written into your original mortgage contract.
The final option for divorced couples who cannot refinance is to sell the house.
Contingency Plan in the Divorce Decree
In some cases, couples may be able to talk to their lawyers about including a contingency plan in the divorce decree. The inclusion of a contingency plan can eliminate the need to go to court for a second time and can include the selling or distribution of the property/assets.
Refinancing: Eliminating Mortgage Insurance
One of the reasons some homeowners refinance is to get rid of private mortgage insurance (PMI.) PMI cancellation can be requested once your loan balance hits 80%, and is automatically canceled once you reach 78%.
In some cases, if your home’s value has increased past the point of requiring PMI, you cannot benefit unless you refinance. If you purchase a $300,000 home and finance at 95% with a 4% interest rate, it would take 55 payments before you would qualify for PMI cancellation. Should your home appreciate at just 4% a year, you can cancel your PMI in only 34 payments. By saving on 21 PMI payments, you may even be able to cover the costs associated with refinancing.
Unfortunately, for homeowners with a newer FHA mortgage, PMI cannot be canceled regardless of home value increase or loan balance. FHA loans now require mortgage insurance premiums which last for the lifetime of the loan. If you want to get rid of MIP on an FHA loan, the only way is to refinance to a conventional loan.
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