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Refinancing a mortgage can offer many benefits, from saving you thousands of dollars in interest to lowering your monthly payments. If your current credit, financial or housing circumstances have disqualified you from a refinance loan, it's not the end of the line. What you do now depends on the reasons you were declined and why you're looking to refinance. Read on.
Why Lenders Reject Refinance Applications
A lender may reject a home refinance application for a multitude of reasons. Chief among them:
- Weak credit score and credit history: Lenders don't like to see late payments and collection accounts on a credit report, since they may be indicators of financial irresponsibility. They may also hesitate to offer the loan if your credit scores are too low. The scores used by lenders typically fall somewhere on a range of 300 to 850, with a score of at least 620 being what many mortgage refinance lenders are looking for. If you are denied a mortgage refinance loan, you will receive what's called an adverse action letter from the lender informing you why your application was rejected. You have a legal right to request a free credit report from the credit bureau the lender used to review your credit.
- Income issues: If your lender believes your income is too low to handle the payments on a new loan, it may reject your application. Inconsistent employment also falls into this category: Lenders like to see that you've held a steady job for at least two years. Or you may have plenty of money to make the new payments, but can't provide evidence with paycheck stubs, W-2s, tax returns or bank statements.
- High debt-to-income (DTI) ratio: Your DTI is the total of your monthly debt payments divided by your gross monthly income. If your DTI ratio is greater than 50% (or sometimes 43% depending on the lender), many lenders will reject your application because it will appear that you're overextended.
- Low home appraisal: If the appraised value of your home is less than what you owe, you won't be able to refinance.
- Insufficient equity: In general, lenders expect you to have a minimum of 20% in home equity to refinance. And if you owe more money than the home is worth, you're what's known as "underwater," which usually results in an automatic denial.
Can't Refinance? Take the Next Steps
There's no reason to accept no for an answer and stop there. By pinpointing the reasons you wanted to refinance your mortgage in the first place, and then taking alternative action, you may be able to achieve your initial goal in a different way. Here are options to consider according to your reasons for refinancing.
Getting Cash Out
Maybe you needed money to pay for home repairs, pay off high-interest credit card debt, buy a big-ticket item or cover expensive medical bills. With a cash-out refinance, your current mortgage would have been refinanced for more than you owe, enabling you to pocket the difference in cash.
Next steps: Even if your credit scores are on the low end, you may be eligible for a personal loan from such companies as Avant, LendingPoint and OneMain Financial, which cater to borrowers with less-than-perfect credit.
If you were turned down for reasons other than your income and credit, a 0% intro APR credit card may help you accomplish your goals. These cards offer an introductory period during which you'll pay no interest on eligible purchases or balance transfers (check card details to see which offers are available). As long as you repay the balance during the intro period, you won't end up with costly debt.
Finally, consider selling valuable but unnecessary property, or delaying what you want to purchase and save for it instead.
Lowering Your Payments
Perhaps the reason you pursued the refinance was to make monthly mortgage payments more affordable. A refinance could have lowered the interest rate and/or extended the loan term, thus lowering the payments so they're more manageable.
Next steps: The first step to take before you miss a mortgage payment is to reach out to your lender and let them know your situation. If you need a temporary break on the payments, consider asking for a mortgage forbearance. You can work with your lender to reduce or suspend payments for a fixed number of months, then make up the missed or reduced payments later.
If you think you'll have problems making payments over the long term, you could ask your lender for a loan modification to either extend the term or reduce the interest rate on your mortgage so you pay less each month.
Other ideas include renting out a room in your home, having adult children contribute financially if they live with you and decreasing expenses. If you're burdened with consumer debt, a Chapter 13 bankruptcy can help you keep your home while you reorganize your obligations in a court-supervised repayment plan—but should only be used as a last resort.
Reducing the Term Length
Another reason to refinance a mortgage is to pay off the loan faster. You might not want to have those payments as you're financing your child's college education or during your retirement years. A new mortgage could have repackaged the existing loan with one that has a shorter term and better rates.
Next steps: Come up with a DIY plan. Review your budget to determine how much supplementary cash you have every month to send to the lender. Contact your lender and explain that you want to pay off your loan faster with additional payments. Ask if penalties for paying the loan off early will apply, and if the lender has restrictions on when you can make extra payments. Specify that the money is for the principal and not the next month's payment, and see if you can add the extra amount to your monthly or bi-weekly payment. Then when you're in a better credit, income or mortgage status position, and if interest rates are low, you could apply for a refinance again.
Improve Your Credit for Future Success
All along, keep a close watch on your credit report. Remember, lenders always read them and the credit scores that are derived from the listed information. Get your free Experian report on a regular basis and read it for accuracy. Watch the progress of your credit score and consider free credit monitoring to catch and offset fraudulent activity that can cause credit troubles.
Improving your credit now can help you avoid a denial the next time you apply for credit. Paying down credit card bills and making sure all your payments are two steps you can take right now to start improving your credit and getting on a solid financial path.
Also consider enrolling in Experian Boost®ø. You can add your phone and utility bills to your Experian credit report, and on-time payments will work in your scoring favor (at no cost to you). When you're prepared to try your hand at refinancing again, your credit reports and scores should also be ready.