If a subprime mortgage was your only option when you bought your home, don’t worry. There’s a chance to refinance it and get a conventional or government-backed loan. You’ll have to put a few things in motion in order to make this happen though.
First, determine why you needed a subprime mortgage. Was it due to poor credit? Maybe your income was not fully verifiable. Whatever the case may be, you’ll have to rectify it through the years. Once you meet the requirements necessary for a conventional loan, you can then consider refinancing.
Perfecting Your Credit
Let’s say you needed a subprime loan because you had poor credit. Taking on a new mortgage loan and paying it on time can help your credit score immensely. Of course, this isn’t the only thing you’ll need to do in order to perfect your credit. We recommend the following:
After a few years of timely mortgage payments, request a copy of your credit report. You can do so here. Once you have the report, go over it with a fine-toothed comb. Look for negative reporting information, such as late payments, collections, or charge-offs. Next, make sure everything is accurate. If you notice any misinformation, ask for it to be corrected. In order to do so, you’ll need proof that it is incorrect. You’ll need to provide the proof to the reporting creditor and the credit bureau.
After you correct any issues and start making your payments on time, give your credit score 6 to 12 months to fully increase.
Stabilize Your Income
Next, you’ll want to look at your income and employment. Did you need a subprime mortgage because you are self-employed and could not fully verify your income? Maybe you used bank statements rather than tax returns. Whatever the case may be, you’ll need to fully document your income with your tax returns, paystubs, and W-2s if you want a conforming or government-backed loan.
Focus on stabilizing your employment and income for at least 2 years. If you are self-employed, decrease the number of write-offs you take on your tax returns in the few years leading up to your mortgage application. This way you can use your tax returns for qualifying purposes. You can always go back to taking those deductions after you close on your mortgage refinance.
Another reason you may have needed a subprime loan is your lack of reserves. This isn’t always a deal breaker, but if you are close to the maximum debt ratio or have a low credit score, it could kill your deal. If you save reserves, you show the lender you are financially responsible and can afford the loan even if your income decreases or stops suddenly.
Try saving between 6 and 12 months of monthly expenses before applying for a mortgage refinance. This way you show the lender financial responsibility. Mortgage reserves aren’t always a requirement for a loan, but they can certainly help your case when trying to get out of a subprime loan.
Work on Your Home’s Value
Lastly, you’ll need a decent value for your home. While you can’t control your home’s value, there are things you can do to enhance it. You can start by properly maintaining the home. Keep up the curb appeal and make sure the home is in good working order. You can also make changes/improvements to the home if you have room in your budget. This can help increase your home’s value.
Conventional loans require at least 3% equity in your home and FHA loans require 3.5% equity. Of course, the more equity you have in your home, the better your chances of approval. If you made timely mortgage payments for several years and your home appreciated, chances are you will have a decent amount of equity in the home.
Once all of the pieces of the puzzle come together, you are then ready to refinance your subprime loan. Refinancing costs money, so you want to try to do it just once. That means waiting until you have the perfect opportunity. In other words, your credit score is great, your income stable, and your home value maximized. This way a conforming or government lender will look at you as a low risk and give you the most favorable terms to help you out of your subprime loan.