4 ways to avoid refinance rejection
What you should know about lender 'overlays,' debt ratios
By Jack Guttentag
"My application to refinance my $200,000 loan was recently turned down ... do I have any recourse?"
If by recourse you mean a third party of some standing who will direct the lender to make the loan, or attempt to persuade them to do it, the answer is "no."
No third party is going to reunderwrite the loan to see if the lender made a mistake. Such mistakes are very rare because lenders make money only on loans they close; they lose money on loans they reject.
Reapplying with another lender
It is possible but unlikely that another lender would approve your loan. Virtually all $200,000 loans are either sold to Fannie Mae or Freddie Mac, and therefore subject to the underwriting rules of those agencies; or insured by FHA and subject to its underwriting rules.
Some lenders place "overlays" on top of these rules, which are more restrictive than those of the agencies. It is possible that your loan met agency requirements but was tripped up by a more restrictive overlay, which would mean that another lender might approve it.
Before applying elsewhere, however, I would discuss your rejection with the loan officer who gave you the bad news to see where your application fell short, and whether it might have met agency requirements.
On the assumption that you did not meet agency requirements, your only option is to change the transaction in a way that will bring it into compliance. The changes required depend on the reason or reasons you were rejected.
Credit score too low
In general, it takes considerable time to raise a credit score significantly, but there are some exceptions. One is where the score is depressed by a reporting mistake, which is not uncommon. As soon as the mistake is corrected, your score will jump. (See "How Do You Correct Mistakes In Your Credit Report?")
Another possible way to juice your credit score is to pay down high balances on your credit cards. A high ratio of balance to maximum balance, called the "utilization ratio," is considered a sign of weakness and potential trouble, reducing your score. Paying down balances to less than 50 percent of the maximums should raise your score.
Finally, you can detach yourself from the "wrong vendors." Because finance companies lend to relatively poor risks, the credit score of any borrower owing money to a finance company is lower than it would be if the creditor were a bank.
By the same logic, borrowers who have credit cards of department stores are penalized, relative to what their score would be if they had cards issued by banks. If you can't pay them off, place department-store cards at the top of your balance-reduction list.
Equity too low
The borrower's equity in his property is its appraised value less the loan balance. Equity can be increased by obtaining a higher appraisal or by paying down the balance.
You don't get a higher appraisal because you need one to refinance your mortgage; you get one because the appraiser made one or more mistakes that reduced value erroneously. You may well know the local market better than the appraiser, especially if he is located a good distance away; you will find his address on the appraisal report.
To make use of your information, however, you must start the process again with another lender. Under current rules, if your existing lender orders a new appraisal, he is obliged to use the lower of the two values.
You can also increase your equity in the house by paying down your loan balance, a process called "cash-in refinance." If you have money in the bank earning 1 to 2 percent, a cash-in refinance that allowed a rate-reduction refinance that would not otherwise be possible would earn a very high return. Of course, you must have the cash to invest.
Debt-to-income ratio too high
In general, underwriting guidelines set maximum ratios of total debt payments to borrower income of 41-43 percent. Debt payments include the mortgage payment, property taxes, homeowners insurance, mortgage insurance (if any), and all other debt payments that extend beyond the next six months and are not deferred for a year or longer.
This includes home equity credit lines (HELOCs) and other revolving credits, credit card debt that you don't pay off at month-end, auto loans, student loans and alimony and child support payments.
If your ratio is too high to qualify, there may be ways to reduce your debt payments. The cash-in refinance referred to above not only increases your equity in the house but it also reduces your monthly mortgage payment. Borrowers who don't have excess cash but do have a 401(k) retirement account can borrow against it and use the proceeds to pay down other debt. Loans from a 401(k) are not included in the debt ratio.
The bottom line is that a loan rejection is not necessarily final, but it is up to the borrower to do what is necessary to convert the transaction from one that does not meet underwriting requirements into one that does.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
Copyright 2011 Jack Guttentag