Why can't I refinance to lower my mortgage interest rate?

Our readers have sent in numerous questions asking why they can't refinance to a lower interest rate, which will make it more affordable for them to stay in their homes.

As interest rates reset, people in adjustable rate mortgages are finding their new rate jump to 7% or more. Meanwhile, mortgage rates for fixed rate loans are available at 5.5% to 6%, and with excellent credit scores possibly lower. So it's natural that these higher-rate people are looking to refinance.

Here's a recent reader question on the subject:

I have a 7% mortgage interest rate and wanted to refinance to a lower rate on my home.I got denied because they said my debt ratio is too high. I'm current on all bills. I keep 6k in savings for taxes insurance (not escrowed) each year. If you can pay the higher interest rate of 7%, why won't they give you a lower interest rate to lower your payments?

What's the answer?While the refinance may be more affordable for you, you've got to remember that banks aren't worried about that as much as they are about getting repaid. If your debt-to-income ratio is too high, the banks will consider you a risk. Right now most banks are looking for a debt-to-income ratio of 29% for home mortgage costs and 41% for all debt.

How does that translate into what you can afford?

Let's suppose you are making $60,000 a year. Multiply that number by 29% and the annual allowable mortgage costs would be $17,400. Divide that by 12 and your total mortgage costs, including principal, interest, taxes and insurance (PITI) can be no more than $1,450 per month with the new loan.

You then need to look at your total debt. Multiply $60,000 times 41% and the annual allowable total debt costs will be $24,600. Divide that by 12 and your total debt cannot exceed $2050. That means you can only have about another $600 in other debt payments ($2050 - $1450). That includes all credit cards, car loans and installment loans.

If your credit score is above 700, you may find a lender willing to work with slightly higher ratios, but in this market that will mean a lot of shopping. You also might be able to find more lenient debt-to-income ratios with an FHA refinance. The current debt-to-income ratios are much tighter than they were in 2005 to 2007, but I don't expect them to loosen up any time soon.

Lita Epstein has written more than 25 books including the "Complete Idiot's Guide to Improving Your Credit Score" and "The 250 Questions You Should Ask About Buying Foreclosures."
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