A theme that has come up with borrowers quite often in my experience are the mortgage unknowns following divorce. The primary question potential borrowers have when contemplating a refinance following a divorce is – Do I qualify?
Without being sure whether a new mortgage is possible – in what other ways can you plan to achieve the objectives you set out to achieve as part of your divorce settlement?
I would like to give you some insight into the 3 primary factors that lenders are going to be looking for in your application to refinance following a divorce.
Actually, these same standards apply for pre-divorce refinances and purchase loans as well. These 3 factors are universal in the world of mortgage finance.
You may have heard of these primary factors referred to as:
The 3 C’s – Credit, Capacity, Collateral
Let’s go ahead and dive into each factor:
1. Credit Score (aka FICO)
What is your FICO score?
A FICO score usually ranges from 300-850. The score itself is an indication of your creditworthiness.
The FICO score takes into consideration a variety of factors, such as your personal history of paying bills, and whether or not you borrow a lot of money (primarily credit cards, student loans, car loans, etc…).
There are 3 credit bureaus that collectively help to determine your FICO – Experian, Equifax, and Transunion.
These 3 bureaus issue your credit scores.
It’s crucial to know that the middle of these 3 scores is what is considered your FICO score.
Though it would be nice to count your high score as the one lenders take into consideration, it doesn’t work like that unfortunately.
Generally, a high FICO score equates to a lower interest rate, and a low FICO score will get you a higher interest rate.
A majority of the largest mortgage lenders require a FICO score no less than 620 subject to the size of your loan and the type of transaction.
It is vital to get your score as high as possible to achieve a higher quality loan.
2. Capacity: Your Debt to Income Ratio (aka DTI)
What is a debt-to-income ratio?
Debt-to-income ratio, commonly known as DTI, is your capacity to repay your mortgage.
The income the lender uses will be factored in against your monthly financial commitments. In other words, monthly debts divided by monthly income.
You basically have your finances boiled down to just one primary factor.
The debts, or financial commitments I’m referring to include your housing expenses (mortgage, property tax, insurance) as well as anything else that may show up on a credit report (credit cards, student debt, auto loans and leases, etc…).
Another big factor in your DTI is both child and spousal support – if it’s to be paid or received, both factor in.
Most of the time, anything over 50% will knock you out of the box entirely when trying to qualify for a new loan.
The DTI cannot and will never be offset by your sizeable bank account balance or any other counterbalancing factors.
3. Collateral (aka LTV – Loan to Value ratio)
If I haven’t made it clear by now, mortgage lenders love acronyms.
It is imperative you don’t let these quick and simple acronyms fool you, they are far more significant than you may imagine.
A LTV ratio is used to establish how much equity you have in your home. The math is basic: take your current loan balance (or balances), divide it by the appraised value of your home, and there you have your LTV.
The lower your LTV the better.
Why is a lower loan to value ratio preferred?
When you consider it…the lower the LTV, the more equity you have in your house. Lenders think of this equity as a sort of protection for the loan they are giving you.
This is particularly significant in a divorce scenario in which a spouse may be obligated to buy out the other spouse’s interest in the family home. Accessing the equity for the purpose of buying out is a direct increase to your LTV. The equity absolutely has to be readily available in order to accomplish a divorce buyout.
As with the FICO score, the higher the LTV then the higher your rate – and vice versa.
Risk continues to be a constant here. The mortgage lender is in a riskier position by lending you an amount of money that is higher in proportion to the value of your home.
You can always opt to pay down the mortgage balance with your own cash in order to get the LTV in line with the lender’s requirements.
It may well be the case that you have a lot of cash, and you may have good relationships with mortgage lenders, but if your application to refinance after divorce doesn’t include all 3 of these primary factors, you’ll unfortunately find yourself looking for a Plan B.
Before stressing yourself out and blindly proceeding on any refinance as part of your divorce (whether it’s a refinance pre-divorce or post-divorce), please be sure to get a clear idea of where you stand on these 3 primary factors.
“Know your 3 Cs – Credit, Capacity, Collateral”