Debt Consolidation Refinance Loan Lending Has Tightened

Debt consolidation refinance loans are commonplace in 2011.  Rolling in credit cards debt and obtaining home improvement funds are two of the most popular things homeowners include in a cash out refinance.

The past 10-15 years people would routinely run up debt knowing that they have equity available to pay it all off if they wanted to.  When the credit card payments got too high, it just made sense to pay it all off with the debt consolidation refinance loan and start over again.  The only problem was that many times the homeowner didn’t learn anything from that experience.  In other words they just kept on spending, spending and spending and instead of accumulating equity in their home, they consumed it.

Banks knew this, but didn’t care because equity was on the upswing and debt consolidation loans were a cash cow to them and all involved.  It was a win-win situation.  A happy homeowner, Loan Officer, and the bank made money as well.

But now if a homeowner needs to payoff debt with the proceeds of the debt consolidation refinance loan, most Fannie Mae and Freddie Mac loans will not allow the loan to be done, also know that different lenders may have their own overlays on this issue.  In a down real estate market where many homeowners have little equity, the bank is more concerned that if they give a homeowner a cash out debt consolidation refinance loan, the homeowner will walk away from the property.  That’s not putting much confidence in today’s homeowner is it!

If a homeowner has ample equity in a home, say it’s ballpark value is $450,000 and they owe $175,000 in mortgages on the home, that should be ample equity to qualify for an additional $40,000 making a new loan of roughly $210,000 right?  They have greater than 50% equity in the home, no brainer right?

Not so fast.  If the homeowner’s $40,000 in debt is all revolving debt that is to be paid off adds up to $1000.000 per month in monthly payments and by paying it off and rolling it into a new mortgage would save them over $800.00 per month that would be saving them a ton of money every month and be a safe mortgage for the bank to invest in right?  In this case wrong.  When doing a monthly payment scenario between the existing monthly payments and what it would be after the loan, the bank underwriters see that this homeowner is struggling to make ends meet.  They are accumulating too much debt and not living within their means and this may mean that they may put themselves right back into the same situation a few years later, so if the homeowner has a debt ratio of 65% prior to the loan, and they need to roll in all the debt into the refinance to get their debt ratios down to 40% the bank may not do the loan.

Sounds ridiculous right?  You have the equity, and paying off the debt would give you so much breathing room which would in turn enable you to make your mortgage payment.  It’s a safer bet for the bank to have a less stressful homeowner who can make an affordable mortgage payment.  That’s not the way Fannie Mae and Freddie Mac (now owned by the government) sees it.  So if a homeowner needs to payoff debt with the proceeds of the loan, they probably won’t be able to qualify for Fannie Mae or Freddie Mac loan.

It seems that the government is trying to force us to live within our means.  They believe that banks were too loose in handing out debt consolidation refinance loans.  But when you make a blanket rule or statement, you are excluding some common sense debt consolidation refinance loans that make sense and can really help people.  This is a kneejerk reaction to yesterdays free wheeling loose lending practices and wild west spending habits of consumers, and now lending has tightened as a result.

There are non-Fannie Mae and Freddie Mac lenders out there that will do the loan scenario above.  It comes with more hurdles and even comes with a rule that states the homeowner must close out each revolving line/credit card that is being paid off.  The lender will issue a letter for each credit line being paid off and it’s included with the final loan papers which requires the homeowners signature.  The lender may even go as far as asking the escrow officer or who ever is signing the final papers with the borrower to take out the actual credit cards and have them cut up by the homeowner with scissors.

This cutting up of credit cards was an old school thing that was done over 20 years ago, but now it’s back!  The debt consolidation loan is still alive and kicking but it’s tougher to get, and comes with more strings attached and even possibly a pair of scissors.

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Best Kevin Walton

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