Reposted from the New York Times by Tara Siegel Bernard
With mortgage rates at tantalizing lows, homeowners are trying to refinance their loans in droves.
Should you join the crowd?
If you have top-notch credit, substantial home equity and expect to stay in your home for several years, refinancing may make financial sense. You probably won’t have any difficulty getting a loan, provided you have adequate income that you can document.
But for everyone else, the calculations have become increasingly complicated. And you’re unlikely to qualify for the lowest advertised rates, which were about 5.12 percent for the week that ended Thursday.
Borrowers now need to clear a number of hurdles that didn’t exist the last time they applied for a loan. Credit requirements are more stringent, borrowers with anything but first-rate credit will be charged more and entire categories of certain loans no longer exist.
Meanwhile, many homeowners have watched the value of their properties drop, erasing much of their home equity. As a result, those homeowners will need to bring new cash to the table to get back to at least 20 percent of equity, an important threshold. Homeowners with less than 20 percent equity are required to buy private mortgage insurance, and the rates have increased sharply in markets where home prices have dropped the most.
For many people, these increased costs are likely to diminish — or negate — the benefits of refinancing.
“It’s important for consumers to operate and analyze a refinancing with their eyes open as opposed to getting stars in their eyes about the lower interest rate,” said Kevin Iverson, president of the Reed Mortgage Corporation in Denver. “So many people say, ‘Oh, I am lowering my rate 1 percent. Then it must be a good thing to do.’ The answer is, well, maybe.”
One of the big factors in determining whether refinancing pays is how long you expect to remain in your home. If you expect to stay for less than two years, you’re unlikely to recoup your closing costs.
It’s probably worth running the numbers if you expect to shave your rate by one percentage point. But, in some cases, that old rule of thumb doesn’t necessarily apply: people with larger mortgages can benefit from smaller rate reductions, brokers said. Smaller reductions may also make sense if you expect to stay in your home for many years.
Of course, you also need to factor in the costs of achieving that rate. Some borrowers pay points, or a fee, to lower the mortgage rate. Points are expressed as a percentage of the loan amount.
Before you begin tinkering with the many refinancing calculators on the Web, be sure to keep the following in mind:
CONSIDER YOUR REASONS First, think about why you want to refinance. Lowering the overall amount you’ll pay over the life of the loan is an obvious one. But in today’s economy, many people are simply trying to save a couple of hundred dollars a month to improve their cash flow (and they don’t care if refinancing will raise their overall costs in the long run). Other people want to get out of riskier loans, like adjustable-rate mortgages.
Or, you may want to take cash out of your home — that is, if you have enough equity — to pay off higher-cost debt like credit cards. If you do, expect to pay more for the privilege. Fannie Mae and Freddie Mac, the two loan guarantors now under government control that buy or insure most mortgages, are charging more in fees when you take cash out.
This is also a good time to reduce the term of your loan. For instance, if you’ve been in your home for a decade, you may consider refinancing from a 30-year fixed mortgage into a 15-year loan. Not only is the rate even lower on a 15-year mortgage, but you will be able to pay off your loan earlier and your payment may be about the same as you’re paying now. That strategy may work well for people nearing retirement.
BE REALISTIC Only borrowers with credit scores of 720 or higher who are borrowing less than 80 percent of their home’s value are likely to get the best rates. Last year, homeowners with a credit score of 660 who were borrowing 95 percent of their home’s value would also have qualified, brokers said. Today, those borrowers may also be subject to a fee of about 1.75 percent of the loan amount.
rivate mortgage insurance has also become more expensive, especially in hard-hit real estate markets, like California, Nevada, Florida and Arizona. By some estimates, the costs of mortgage insurance have risen anywhere from 16 to 40 percent, depending on your location, credit score and amount of home equity.
“Once you put all of this stuff in the blender, you say, ‘Golly, with 20 percent down it might be 4.75 percent. But with 5 percent, it’s up to 5.75 percent,’ ” Mr. Iverson said.
SHOP AROUND There are huge variations in mortgage pricing across lenders. That’s because the entire industry — from lenders to title companies — has laid off workers and is now operating with skeleton staffs. Some lenders will tap on the brakes by raising their rates when they can no longer handle the immense volume of loan applications. Since rates change daily and vary by lender, it pays to do your rate shopping on the same day to perform a valid comparison, said Jack Guttentag, professor of finance emeritus at the University of Pennsylvania’s Wharton School who runs the Web site mtgprofessor.com.
And pay close attention to points, the fees paid to lower your rate. Historically, paying 1 percent of your loan would lower your mortgage rate by about a quarter of a percentage point, said Mike Stoffer, a broker in North Canton, Ohio. But at some lenders, it can now shave 0.50 percent off your rate, he added. (The longer you expect to stay in your home, the more sense it makes to pay points to lower your mortgage rate.)
Clearly, it pays to price multiple providers. Start by asking your current lender what they can offer because sometimes you’ll be able to save on closing costs. And if you are having trouble finding financing that suits your needs, check with your credit union and smaller banks and thrifts.
RATE LOCKS Given the high volume of applications, it’s also important to ask the lender when the loan will close — and what happens to your rate if the loan fails to close before your rate lock expires. Such locks typically guarantee your loan pricing for 30 to 45 days. Get your rate lock in writing. Rates aren’t expected to rise anytime soon, but even if they move only slightly higher, it can diminish the benefits of refinancing. Rate locks can cost money, so factor this into your cost comparisons across lenders.
“Delays are going to happen in this kind of environment,” said Keith Gumbinger, vice president of HSH Associates, a financial publisher. “The time to ask what happens to my rate when my rate lock expires is not at Day 30.”
CONSIDER F.H.A. Many borrowers with less than 20 percent in home equity are having an easier time getting new loans or refinancing through the Federal Housing Administration, which insures lenders whose loans meet its guidelines. F.H.A. loans require as little as 3.5 percent down, though borrowers will pay an upfront mortgage insurance premium of 1.5 to 1.75 percent (usually tacked onto the loan amount), and pay a slightly higher interest rate. But for some borrowers with less than 20 percent in equity, an F.H.A. mortgage may be a more cost-effective option. And for people with less than 10 percent in equity, it may be the only option. “Make sure to go to a loan professional who can explain the pros and cons of F.H.A. and conventional loans as it relates to each individual situation,” Mr. Stoffer said. Many people don’t use F.H.A. loans, he said, because there is still a stigma attached to using them and they’re viewed as harder to obtain. In addition, not all lenders are approved to make these loans, so they steer people away from them.
UNDERSTAND THE RULES You will also need to document your income fully, and you can expect lenders to check it with the I.R.S. — something they didn’t do previously. “Every data item is being verified at least once,” said Christine Clifford, vice president of Access Mortgage Research & Consulting.
If you’re looking to refinance a jumbo loan, you need to have superior credit and a sizable amount of home equity. “You have to provide income verification and the bank wants to make sure you have reserves or liquid assets in the bank,” said Bob Moulton, president of Americana Mortgage Group, a jumbo broker in Manhasset, N.Y. That means three to six months of mortgage payments and insurance.
CLOSING COSTS Request closing costs in writing. While lenders are required by law to provide what’s known as a good-faith estimate of these costs within three days of applying for a loan, one broker recommends asking for it while shopping. “If they aren’t willing to share with you their costs, that is a red flag,” Mr. Stoffer said.