The #1 question most clients have when considering a refinance after divorce is – Do I qualify?
Without knowing for certain whether a new mortgage is feasible – how else can you plan to accomplish the goals you set out to accomplish as part of your divorce settlement?
In this article, I want to give you a glimpse into the 3 Key Ingredients that lenders are going to look for in your application to refinance after divorce.
In actuality, these same criteria apply for pre-divorce refinances and purchase loans too. These 3 numbers are universal in the world of mortgage finance.
You might have heard of these key factors referred to as:
The 3 C’s – Credit, Collateral, and Capacity
Let’s go ahead and take a closer look at each:
#1 – Credit Score (aka FICO)
What is a FICO score?
A FICO score usually ranges from 300-850. The score itself is an indication of your creditworthiness.
The score takes into consideration a number of different factors, such as your history of paying bills, and whether you borrow a lot of money (such as credit cards, car loans, student loans, and so on)
There are 3 credit bureaus that collectively help to determine your FICO – Experian, Equifax, and Transunion.
Those bureaus issue your credit scores.
It’s important to understand, the MIDDLE of these 3 scores is going to be your FICO score.
In other words, not the highest score, not the lowest score, but the score that falls in the middle.
In general, a high FICO score equates to a lower interest rate, and a low FICO score equates to a higher interest rate.
Many of the top lenders expect a FICO score no less than 620 depending on the size of your loan and the type of transaction.
If you miss the mark, it’s going to cost you.
#2 — Collateral (aka LTV – Loan to Value ratio)
First of all, If you haven’t caught on by now, banks LOVE acronyms.
Don’t let these cute acronyms fool you – they are more important than you might think.
An LTV is used to determine how much equity you have in your home. The math is simple, take your current loan balance (or balances), divide it by the appraised value of your home, and you have your LTV.
The lower the LTV – the better.
Why is a lower loan to value ratio better?
Think about it – the lower the LTV, the more EQUITY you have in your house. Lenders consider this equity as protection, protection for the loan they are issuing you.
This is especially important in a divorce scenario in which a spouse may be required to buy out the other spouses interest in the family home. Tapping into equity for buyout purposes is a direct increase to your LTV. The equity MUST be there in order to accomplish a divorce buyout.
As with the FICO score, the higher the LTV the higher the rate – and vice versa.
“Risk” remains constant here. The bank is in a riskier position by lending you an amount of money that is higher in proportion to your property value.
Quick Tip: You can always opt to pay down the mortgage balance, with your own money, to get the LTV in line with the lender’s requirement.
Finally, the third (and in my opinion the most critical number to your application) is
#3 – Your Debt to Income Ratio (aka DTI)
What is a debt-to-income ratio?
Debt-to-income ratio, also known as DTI, is your capacity to repay your mortgage.
The income the lender uses will be factored in against your monthly obligations. In other words, monthly DEBTS divided by monthly INCOME.
Voila – you essentially have your finances boiled down to just one key ingredient.
The debts, or obligations, I’m referring to include your housing expenses (mortgage, property tax, insurance) as well as anything else that might appear on a credit report such as (credit cards, auto loans and leases, student debt, and so on).
Another huge factor in your DTI is both spousal and child support – whether it’s to be paid OR received. More on that in another article.
In general, anything over 50% will (in most cases) knock you out of the box completely when attempting to qualify for a new loan.
As with LTV, the DTI cannot and will not be offset by your “large” bank account balance or any other compensating factors.
At the end of the day you might have a lot of cash, and you might know the bank well, but if your application to refinance after divorce doesn’t include all 3 of these key ingredients, you’ll quickly find yourself looking for a Plan B.
Before spinning your wheels and proceeding on any refinance as part of your divorce (whether it’s a refinance after divorce or before divorce), make sure to get a clear idea of where you stand on these 3 key ratios.