Mortgages obtained for a home purchase are seldom held for the entire term of the loan. Most homeowners will refinance the original loan at least once at some point during the term while some borrowers will refinance several times. Each homeowner’s decision for taking on a new mortgage is unique, although the final results of the refinance may come as a surprise. In many cases, debt consolidation is necessary when refinancing in order to receive approval.
When homeowners apply for a typical refinance, they often have their own plans of what type of loan they want, the term of the loan, etc. In fact, having knowledge of this information is highly recommended and reaffirms that the borrower has a financial plan in mind. However, once the refinance application has been submitted, the process begins and the result may produce some issues that were not considered, in particular, debt that is held by the borrower.
The Debt to Income Ratio
The debt to income ratio (DTI) is an important part of the mortgage transaction and can actually make or break the deal. Depending on the type of refinance the applicant has applied for, the mortgage program will have guidelines for the acceptable debt to income ratio. In some cases, lenders add overlays, or additional restrictions, which can further reduce the DTI. Borrowers must be within the DTI limits of the mortgage in order to receive approval.
Very often, when there is other debt involved, the debt to income ratio can be too high and not within the loan program guidelines. When this happens, it can change the entire refinance that the borrower initially expected to obtain. A no-cash out refinance can then become a cash out refinance. Or a cash out for that long awaited swimming pool may have to be put on hold. This happens when existing debt needs to be paid off in order to bring the debt to income ratios within the lender’s guidelines. In some cases, several debts may need to be paid off. Paying off higher credit card debt that carries high minimum monthly payments can reduce the DTI even though the mortgage amount has been increased since the mortgage refinance rate is much lower that the short term credit card rate and the term of the loan is much longer. When this happens, it is most likely the title company or closing attorney who will be paying off the debt with the funds from closing.
Which Debt Should be Paid?
In many cases, automated underwriting systems will indicate what debt needs to be paid off in order to reduce the risk of the refinance. If a borrower has assets that can be verified, debt can be paid with the available cash provided that any necessary reserves remain in place. It is important to understand that every process done to fix one issue, can change something else and have an affect on the loan. It can happen that a cash out refinance, for which the funds were going to be used for home improvements, turns out to be a cash out refinance for debt consolidation instead with no cash left remaining for the intended purpose.
The best way to approach a refinance is to know your financial standing and reducing debt prior to submitting an application. While everyone today is concerned about loan to value, it may actually be debt to income that really becomes an issue.
Author Bio: Rosemary has been writing since 2010 for FreeRateUpdate.com, a company that matches consumers with banks and lenders offering low mortgage rates. Previous to her writing career, Rosemary spent 13 years working hands-on in the mortgage industry as a mortgage loan analyst, mortgage processor, mortgage underwriter and a property manager.
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