Can You Refinance? Here's How to Figure it Out

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By Scott Sheldon

Mortgage rates were near their 20-month lows at the end of January, prompting many homeowners to seek to refinance. All too many have wanted to in recent years, yet held back because they thought their house would not appraise for what they needed to make the numbers work. Here's the skinny if you're debating whether to go for the refinance.

HARP 2.0 Refinance Program

The program allows homeowners whose mortgage loans closed on or before June 1, 2009, and are owned by Fannie Mae or Freddie Mac to refinance their house no matter what their loan-to-value is, with no occupancy restriction. Even if you have an investment property with a 200% loan-to-value ratio, the program allows for anyone -- no matter what their loan-to-value ratio is -- to qualify, independent of any valuation restrictions. The refinancing lender may or may not need a full appraisal based on the property and your credit, debt, income and assets. Fannie Mae or Freddie Mac, whichever entity owns your loan, makes the determination about whether an appraisal is needed, not your lender.

FHA, VA, USDA Streamline

If you have a government loan, not only do you not need an appraisal for these programs, you don't need to provide tax returns and W-2s either. A streamlined program under any one of these three types allows you to refinance without an appraisal and with lighter financial documentation, as long as you're sticking with the same loan program (for example: FHA to FHA). Additionally, all three of these loan programs offer very high loan-to-value options. You can do an FHA loan up to 97% financing on your home; a VA loan will go up 100% financing on your home, as will a USDA loan. These present three additional financing alternatives if you are running the risk of having little equity in your home for refinancing.

The Benchmark for Equity

Another viable opportunity for homeowners unsure of their equity is the possibility of lender-paid mortgage insurance, an option where the lender pays the private mortgage insurance you otherwise would be incurring every month as a result of having less than 20% equity. This means you wouldn't pay PMI despite not having the 20% equity.

In the lending world, 20% equity is the benchmark for ideal home equity-to-value. Let's say you owe $350,000 on your home, and are hoping for a value of $440,000 to complete your refinance. Your appraisal comes in at $425,000, putting you just a hair over 80% loan-to-value. In this situation, to complete the transaction you typically have to pay the closing costs the lender is charging as well as pay down the principal balance to 80% of the value of your home to avoid PMI. If you don't have the additional cash to refinance and remove the PMI on your current mortgage, lender-paid mortgage insurance may work for you. Lender-paid mortgage insurance will usually go as high as 90% financing on homes, all the way to the maximum conforming county loan limit in the area where the property is located.

Put Your Money to Work for You

OK, so you're not eligible for a HARP 2.0, you don't have a government loan, and for whatever reason, a new government loan still just doesn't make sense. You're left with two choices: Have the lender renegotiate the value with the appraiser in order to induce a higher valuation on your home (this is usually only supported by additional comparable properties the appraiser did not originally include in the report), or pay down the difference between the appraised value and the new loan amount.

Many may not be too thrilled with the possibility of having to bring in several thousand dollars to close escrow based on a low appraisal report. However, short-term interest rates on other assets are still very low. Your mortgage lender could easily run a scenario showing you your cash-on-cash return by paying down the principal to generate a larger monthly savings on the refinance.

Let's say in addition to the general closing cost of $3,200 to refinance, your appraisal came in lower and you have to bring in an additional $10,000 to close escrow. Otherwise, you can't get the loan because the appraisal did not come in high enough. Investing the additional $10,000 would free up $400 more per month -- in addition to the original refinance savings of, say, $200 per month. In other words, the potential monthly savings by bringing the additional cash is $600, and $600 a month over 12 months is $7,200. The total capital needed for the transaction is the $3,200 in closing costs plus a $10,000 principal balance contribution, totaling $13,200. In one year, that's a 54% return on your money, and it only compounds over time. The takeaway: Before you back out of a transaction because the appraisal came in lower, look at the real opportunity in the numbers.

If All Else Fails...

Having an appraisal in hand is a measure of how much more in value you'll need in the future to pull off a refinance later. Follow up with a qualified professional about the possibility of what your home could be worth, say, six months from when the appraisal was completed. This could be your loan officer, a real estate agent -- or if you happen to know an appraiser, all the better. More than likely, down the road your house could be worth what is needed -- many markets are showing strong gains -- to complete the refinance. At the same time, if you are on an amortizing loan, your balance is continuing to drop each month.

Finally, keeping your credit in good standing can help you all the more when it's time to refinance. Checking your credit reports and credit scores regularly can keep you up to date on your status, and alert you to any problems you need to work on or correct. You can get your free credit scores on Credit.com, updated monthly, to track your progress.

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