Refinancing Do's and Don'ts

For Ernie and Laura Anastos of Arlington, Va., 2010's historically low interest rates couldn't have come at a better time. After careful analysis, the couple ditched their 7-year-old balloon mortgage with its 5.375 percent interest rate in favor of a 4.75 percent, 20-year fixed rate.

Their monthly payments have risen slightly, but thanks to mortgage refinancing, they shaved three years off their mortgage and could save more than $80,000 over the course of the loan.

"It made a lot of sense. Because it was a balloon loan, we knew we'd have to refinance at the 10-year-mark, and interest rates are low now," Laura Anastos says.

The Mortgage Banker's Association, an organization that monitors and represents real estate financial institutions, predicted in late 2009 that loan applications for mortgage refinancing would tumble by more than 52 percent in the following year. This was based on an assumption that financial institutions would raise rates to ward off inflation.

But rates have remained low, largely because of global financial instability, and current homeowners are wondering whether they can take advantage of the situation.

Average rates on a 30-year-fixed loan in mid-year 2010 were 5.0 percent, according to mortgage giant Freddie Mac. This is down from the 2009 average of 5.04 percent for a 30-year fixed loan.

To get rock-bottom rates, however, homeowners must be eligible. And that means they must do the math, make sure their financial portfolio is primed for review and shop around for the best rates.

If you're considering a mortgage refinancing, here are some tips to help you decide whether now is the right time to refinance your home:

Check the Costs

First, examine your loan and see whether it makes sense to refinance. Speak with a mortgage broker or officer to determine by how much you would reduce your monthly payments and how long it will take to recoup closing costs on the new loan.

Or use a mortgage calculator yourself to determine whether you'll lower your bills. Remember that you'll pay loan origination fees and discount points. Also, keep in mind that you've already paid into a loan. Will the new mortgage have you refinancing another 30-year mortgage, adding onto the years you'll be paying for your house? Or will it shorten the term of your loan?

You, like the Anastoses, might want to consider refinancing for a mortgage with a shorter term. If you plan to stay in your home for years, you might be able to shorten your loan while keeping the costs similar to what you are currently paying. The Anastoses, if they stay put, will pay off their mortgage in 27 years or less (Laura also likes to make additional payments on the principal). If they decide to sell, they'll have built up more equity in their home by opting for the shorter-term loan.

Clean Up Your Credit and Finances

You've seen the advertisements about poor credit scores and their effects on your finances. Get your financial portfolio in shape for the best rates. Start by getting a copy of your credit score and record. You're sitting pretty if your score is roughly 740 or higher.

If it's below 740, spend a few months boosting your score before applying for a loan: Pay off credit cards; pay down or eliminate car loans; and lobby to remove any errors on your record.

While reviewing your credit score, also assess your finances. Companies have returned to old-fashioned math to determine who is eligible for loans. Specifically, they believe a consumer's housing debt should not exceed a quarter of their monthly income. For example, if you have a mortgage payment of $2,000, lenders believe you should gross at least $8,000 a month.
In considering whether you are a good loan candidate, banks also may look at other debt, such as credit cards, and car or student loan payments.

If other loans put you at a total debt-to-loan ratio approaching 50 percent, you'll likely face difficulties obtaining a refinancing loan.

Shop Around

If you determine you are a good candidate, start looking for the best rates and costs. Start with your current lender. If you are a customer in good standing, the company may give you breaks on fees and requirements, saving you up-front costs and lowering your payments.

If the company won't budge, actively compare interest rates and lenders. Ask for recommendations from friends and colleagues and find companies which offer the lowest interest rates, fees and closing costs.

Steer clear of "no cost" refinancing, especially if you plan to hold onto the property. Basically, "no cost" means the costs will be rolled into the mortgage, which means you'll pay interest on them over the life of the loan. It's usually better to pay the points up front for a lower rate and pay any fees with a check at closing.

Be Prepared for What You'll Find Out

Mortgage refinancing is like buying your house again. You will have it appraised, and depending on when you bought the home, be prepared for surprises. According to Consumers Union, many lenders require you to have at least 10 percent equity in your home. Check comparable sales in your neighborhood to help determine what your home might be worth under current market conditions.

Expect to Wait

Mortgage companies are keeping their loan officers on tight reins: Remember that in this conservative loan climate, mortgage refinancing can take more than a couple of months. Consumers Union recommends asking lenders to lock-in rates for at least 60 days or more. Make sure the lock-in is free – ask your loan officer specifically if there are any fees or whether you'll be charged a higher mortgage rate for the lock-in protection.

Buyer's Remorse?

If the closing goes poorly, and you're refinancing your primary residence and have not refinanced with your current lender, you have three business days to cancel the deal. It's called the right of rescission.

Say you found unexpected fees or felt pressured by the loan officer to sign something you didn't want to; you can notify the lender in writing within the three-day grace period.

The lender has 20 days to return your fees.

See our guide to learn about "Four Ways to Benefit from a Cash-In Refinance."


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