Time to refinance: Eight steps to getting the best deal now

With the Federal Reserve aggressively cutting interest rates, you may be wondering if it's time to refinance your current mortgage. The answer is a simple yes. Back in January I locked in a 4.5% 15-year fixed rate mortgage the day after the Fed rate cut. Rates went back up to 5.5% within a week.

Generally you will benefit from a refinance as long as your interest rate will go down by at least 1% and the new loan does not require you to pay points in order to get that lowered rate. In most cases, a refinance is only worth it if you plan to stay in the home for more than three years. If you think you'll be selling the home before that, the costs of a refinance probably won't be recovered unless you can lower your rate by 2% or more.

With interest rates so low, the only kind of mortgage you should consider today is a traditional fixed-rate mortgage. Lock in those low rates. Don't play games with variable rates. If you can't afford the payment on a 30-year fixed-rate, consider a 40- or 50-year mortgage rather than a variable rate mortgage. You can always make extra principal payments when you can afford them to shorten the life of the loan in the future. But, of course, be sure your loan doesn't have any pre-payment penalties. Never accept a mortgage loan with pre-payment penalties. Ask that question when you're shopping for a loan and ask it again before you sign the papers to close the loan. Make sure you see in writing that there are no pre-payment penalties before you close the loan.

Check your credit report and score. Before applying for any new major loan it's a good idea to check your credit report and credit score. If you find any erroneous information on your credit report, clean it up before you start the application process. Cleaning things up as part of the underwriting process will only delay the loan process and could even kill the loan. To get the best rates, your credit score must be 730 or higher. People with this credit score can often get rates below the national average rate you'll see quoted around the Internet. If your score is below 675, you will pay significantly higher rates than you are seeing quoted. People with scores between 620 and 674 generally pay 1.5% to 1.9% higher rates for a mortgage. People with scores between 560 and 619 will find their rates are about 3.8% higher than the national average, if they can find a lender at all in today's tight mortgage market. Below that you'll probably find it almost impossible to get a refinance in today's market. You can use the round robin debt startegy to improve your score quickly.

Start your search for a new loan by contacting your current lender. When I'm considering a refinance, the first call I make is always to my current lender. As long as you've been paying your mortgage on time every month, most lenders want to find a way to keep you as a customer. But don't expect your best deal on your first phone call. Lenders' first offers usually tend to be higher than the final offer you'll get if you shop around. When the Fed cut rates by 0.75% in January, I made a call to my lender that day. My rate was 6.04% on a 15-year loan and I knew I could lower that by at least 1% so it was time to consider the refinance. It worked. I closed on 4.5%, 15-year fixed rate loan earlier this month. You do get your best rate offers on the day of a Fed cut and for one or two days after a Fed cut until the competition sorts itself out. So the window of opportunity is open with the Fed cutting rates by 0.75% again.

Shop for rates. Never accept the first offer you get from your bank. Always shop for rates. I've had a lot of success finding decent offers through Lending Tree over the years. Interestingly the last couple of times I used Lending Tree my bank was one of the five bidding for my business. Once your bank sees you in the bidding war the offers get much better. In today's volatile market, a solid, good paying customer is someone a bank does not want to lose.

Refinance or refinance with cash out. If you have both a mortgage and an equity line, one of your key decisions will be to just refinance your first mortgage or to fold in your equity line and possibly your credit card debt, so you have only one payment. You should avoid paying off credit card debt (which is unsecured) with a secured loan. While a credit card company can never foreclose on your house if you can't pay a bill, a lender holding your mortgage can foreclose on your home. An equity line is different. That too is secured debt, so if you can lower your interest rate on the balance in the equity line, you may want to pay that off as part of the refinance. But, you will get a better interest rate offer with a straight refinance. When you pay off an equity line it's called a refinance with cash out. In my recent attempt to refinance I found the cash out would result in an interest rate of 0.35% to 0.5% higher for the first mortgage. That may not sound like a lot, but over the course of 15 years on a sizable loan it adds up. Since I have so little on my equity line and it's variable rate was pegged to below prime, it made more sense for me just to refinance the first mortgage. So, always be sure to look at the rates for both a straight refinance and a refinance with cash out. Calculate total interest costs of both options. Use this mortgage payment calculator to calculate payments and total interest paid for both refinance options. To get total interest paid click on the link that says "Show/Recalculate Amortization Table." At the bottom of the amortization table, you'll find the total interest for the loan you input.

Let brokers who call discuss various options they offer. Mortgage brokers from each of the banks competing for your business will get very creative to get your business. They only way they make money is when they close the sale. Don't let them talk you into a mortgage you don't understand, but do let them discuss different options for whether or not to refinance or refinance with cash out. They can help you sort out what might be best for you given your current loan situation. By talking with four or five lenders, you can then sort out the information and make the best decision for yourself. Just remember, they are sales people on commission so don't get caught up with a slick talker. Take your time and compare offers.

Compare apples to apples. Before making a decision about a new mortgage, always ask each lender to send a "Good Faith Estimate." While they can fudge the offer by not giving you the total costs of closing, the "Good Faith Estimate" is a federal form that makes them lay it all out on the line. By requiring this form before agreeing to any offer, you will then more easily be able to compare closing costs. In some cases I found the "Good Faith Estimate" of one bank's bottom line looked better, but when I started looking at costs unique to my state (such as tax stamps), the out-of-state lenders had underestimated these costs dramatically making their bottom lines look better. So I knew that closing costs would be about the same in the end for the two or three lenders who gave the best offer.

Call back your current lender. With these offers in hand, I was then able to negotiate with my current lender for a better deal. When I told him the rates I got and reviewed his closing costs in comparison, he then came up with an offer I couldn't refuse. My initial interest rate offer from my bank was for a 4.85% loan with closing costs of $5,900. To keep my business I got an offer of 4.5% as long as I did a straight refinance without a cash out and my closing costs were lowered by $900 to $5,000 because certain costs, such as a reissue of my title insurance, could be cut. So I'm ending up with a 1.54% reduction in the interest rate on my 15-year mortgage. I'll be able to recoup those costs in about two years. You can find out how long it will take you to recoup your refinance costs with this calculator from Lending Tree. The cash I'm saving on my first mortgage will go toward paying my equity line off sooner.

Consider a float down option. Since the Fed may lower rates yet again, it's a good time to consider a float down option. That way you lock in today's low rates, but if rates drop between today and when you close your loan the float down option will allow the lender to unlock the loan, lower the rate and then relock the loan. It costs about 1/2 a point up front, but that is credited toward closing costs. Paying that fee does lock you into the lender. You certainly don't want to lose it by closing the loan with another lender. So be sure you've done your shopping before you agree to a float down option.

Lita Epstein has written more than 20 books including the "Complete Idiot's Guide to Improving Your Credit Score" and "The 250 Questions You Should Ask to Avoid Foreclosure."

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