Refinancing a home in which you have less than 20 percent equity can be challenging. Especially if your equity is less than 10 percent of the home's market value, the refinancing represents a serious risk to the lender. There is hope, however, as the Federal Housing Administration insures exactly these sorts of loans.
Contact Your Current Lender
Contact the lender that made the initial loan on your home and ask for guidance on refinancing. It is almost always better to first talk to your current lender for the refinancing since it is in the lender's best interest to lower your monthly payments to minimize the risk of a default. The lender will also have access to your records, which saves time. If your equity is below 10 percent, the Federal Housing Administration's loan guarantee program may be the only option for refinancing. Find out whether your lender participates in this program and ask your account representative whether you qualify, given your credit score and financial ratios.
Check Other Lenders
If your existing lender does not participate in the Federal Housing Administration's program or offers higher rates than what you can get elsewhere, contact other lenders. Note the full closing costs as well as the monthly payments that you will likely qualify for. Often, the institution that offers the lowest monthly payments does not have the lowest closing costs, and you must accept a tradeoff between lower payments upfront or lower monthly expenses until the end of the mortgage term. In some cases, even the best offer is not worth taking. If you must pay $1,000 upfront and will save only $10 per month, it will take 100 months for the refinancing to pay off. If you have less than eight years on your current mortgage, you will lose money with such a refinancing.
Enhance Your Chances
If prospective lenders tell you that you won't qualify even for an FHA-guaranteed loan, ask whether lowering your debt-to-income ratio may help. This ratio is a critical measure and may be the chief reason your chances look bleak. You can lower this ratio by paying off any outstanding debt, such as your credit card balances, auto loans or open lines of credit with retailers. Increasing your monthly net income, if possible, will also lower this ratio and improve the probability of an approval. Sometimes, neither of these two routes is possible in the near term and waiting for a while is your only option.
Complete the Application
Once you determine that a refinancing is worthwhile and likely to be approved, fill out the mortgage application form and provide all required documentation, including proof of income, Social Security number and proof of ownership of your home. If the application is approved, you will sign the closing documents and either make a cash payment for the closing cost or negotiate with your lender to add these costs to the loan balance, eliminating the need for any upfront payment.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.