|How to buy home by refinancing another
An important home buying hurdle you’ll need to clear is the relationship between the proposed new housing payment and current liabilities against your monthly pre-tax income.
The payment to income ratio on debts, including other debt houses you own, plays a vital role for the mortgage broker determining how much house you can bite off.
If your payment to income ratio, is more than 45 percent, you’ll need to buy less house or reduce debt. The following is an out-of-the-box approach to get you closer to getting the keys.
The payment-to-income ratio, also known as the debt to income ratio (DTI), is expressed as the amount of each monthly payment on all liabilities associated with houses, cars, credit cards, student loans, installment loans, personal loans, government and marital and child support obligations. All of these obligations against a proposed housing payment divided into your gross monthly income reveals your payment to income ratio, and the magic number lenders use is 45 percent on most loan sizes.
For example, you have consumer obligations at $300 per month, looking to take on a mortgage payment at $2,500 per month and the monthly income you earn pre-tax is $7,000 per month. Consumer obligations at $300 per month plus the proposed mortgage payment of $2,500 per month divided by $7,000 equals 40 percent. A very healthy payment-to-income ratio indeed for any mortgage broker.
Numbers get interesting
If you own other properties, such as another single-family residence, a condominium or a multi-family property, any and all debt associated with another property would have to be factored into the complete qualifying formula. The same reasoning and logic applies for another house payment using the payment to income calculation.
• Key tip 1: If a consumer has one or more indebted properties and is looking to acquire another property and the payment-to-income ratio is too tight or too high, in order to account for the purchase price point range they want to be in, the next best alternative rather than forking over more cash, is to consider refinancing to reduce the payment on the other home/homes they own. Doing so, reduces the minimum payments, improving borrowing power thus inflating the potential purchase price of the new home while lowering the payment to income ratio.
Refinancing – golden
ticket to buying a home
• Lengthening the term: Lengthening the term improves borrowing ability because it reduces the minimum monthly mortgage payment. Lengthening also increases the interest paid over the total life of the loan resulting in higher interest expense, unless principal prepayments are made or the property is sold off sooner than term is up. Since refinancing to qualify is a strategy to make the numbers pencil, a prudent mortgage consumer would also consider the longer term plan in keeping that property, renting it for cash flow or possibly selling in the future.
• Reducing rate: As long as you’re going from the same term to the same term or from a shorter-term to a longer-term, reducing the interest rate is always a viable way to reduce the payment to income ratio as the debt associated with the property also will be lower.
• Removing private mortgage insurance (PMI): Refinancing to reduce any PMI associated with your monthly mortgage payment will have a strong and dramatic affect on your ability to qualify for a new mortgage especially if the PMI is several hundred dollars per month or more.
• Key tip 2: It’s not uncommon to expect a $300 per month in refinance savings can translate up to $40,000 in purchase price.
• Cashing In equity: This can be accomplished with a second mortgage, such as a home equity line of credit or even doing the first mortgage to pay off consumer obligations or any other liability hindering your ability to purchase a new home. Since mortgage interest is primarily deductible, this can be a very attractive option for many seeking to improve their cash flow while at the same time being able to purchase a bigger, better home.
Before you refinance another property to improve your home buying chances, ask your mortgage broker how much more borrowing power you’ll gain by taking the plunge. This is a critical first step as the goal of refinancing is to get closer to the prize. Of course, you always improve your loan chances by forking over more cash to increase your down payment, but this approach isn’t always the greenest route because of the reserve requirement (money savings in bank post closing escrow) most lenders have when acquiring real estate.
As with any mortgage loan, your complete ability to qualify will be based on your payment to income ratio, job history, credit score, credit history and the amount of cold hard cash you have available to play with for a down payment and closing costs and those lending reserves.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.