Republished with Permission 2009 Nolo.
by Alayna Schroeder
How to refinance your mortgage in today`s depressed real estate market.
Today`s economy and struggling real estate market pose challenges for many homeowners. For those facing adjusting rates, increased mortgage payments, decreased equity, or reduced income, refinancing a mortgage or home loan is one good way to solve some financial worries. With property values falling and companies tightening their belts or even laying off employees, theres no better time to make sure your mortgage meets your current budget and long-term needs.
What Is Refinancing?
When you refinance, you get a new mortgage to replace your existing mortgage. Because youre getting a brand new loan, you usually have to pay title insurance and escrow fees, lender fees, points (optional), appraisal fees, credit reporting fees, and any amounts needed to bring your insurance and tax obligations up to date.
Homeowners refinance for many different reasons, but here are some of the most common ones, all at play in todays real estate market.
Refinancing can save money by lowering your interest rate. If the interest rate on your current mortgage is higher than the current market rate, you`ll pay less by refinancing.
Refinancing allows you to change loan types. For example, if you have an adjustable rate mortgage, your monthly payment may increase when the rate adjusts. You might want to switch to a fixed rate mortgage, which has a stable payment.
Refinancing can lower monthly payments. Even if your interest rate doesn`t decrease, a refinance can lower your monthly payments by starting a new loan term. For example, if you took out a 30-year, fixed-rate mortgage for $300,000 10 years ago, you may only owe about $250,000 now. But if you refinance into another 30-year, fixed-rate mortgage for $250,000, you`d have a full 30 years to pay it off, which means each monthly payment will be smaller. (Had you kept your old loan, you`d finish paying it off in 20 years.) The downside of lowering your monthly payments is that you`ll pay more interest overall.
Refinancing can help you get cash. With a cash out refinance, you take out a new mortgage for more than you owe on your current mortgage, then walk away with the difference. Many homeowners do this to finance home improvements. (An alternative that`s usually cheaper overall, but requires you to make higher monthly payments, is a home equity loan or home equity line of credit). To do a cash out refinance, you need significant equity in your home, because the bank probably won`t lend you more than the house is worth.
Who Can Refinance?
Anyone with sufficient equity can refinance. A lender will consider the same factors your original lender did: your income, debt-to-income ratio (how much of your monthly income is spent paying off debts other than the mortgage), and your credit score. If your income has been reduced since you purchased, you`ve assumed a lot of new debt, or your credit score has gone down, you may find it difficult to refinance, or you`ll at least pay more to do so.
The lender will likely also require you to have the house appraised. The purpose of the appraisal is to make sure that the value of your home is greater than the loan amount. If you default on the loan and the lender forecloses, it wants to know it can sell your house for more than the existing loan balance.
When to Refinance
Refinancing won`t be the best solution in every situation. Check to see if the refinance will pay for itself in the reduced interest rate you`ll pay.
Your calculations will tell you three important things.
New monthly payment amount. First, you`ll find your new monthly payment amount, which will hopefully be lower. But thats not the end of the story.
Breakeven point. Youll also find your breakeven point: how long it will take you to work off the initial closing costs by saving on interest each month. If you think you’ll stay in your home for less time than it takes to reach your breakeven point, the refinance definitely isn’t worth it. In that case, you may want to consider a no-cost refinance: you wont pay anything out of pocket, but your interest rate will be a little higher or the costs will be added into the principal on your loan, meaning youll pay them off over time (with interest).
Total interest youll pay. Finally, youll find out the total interest youll owe. Starting over with a new mortgage term (most likely 30 years) means adding several months or years to your payment schedule. The more time you take to pay, the more interest you’ll owe in total. If your main objective is to lower your monthly payments, you may want to refinance even if it means youll pay more interest over the long term. If you can later afford to increase your payments, you can refinance again, or simply pay extra to reduce the principal on your current loan.
Special Challenges in Today`s Buyers’ Market
Refinancing these days is harder than it once was, for a few reasons.
First and foremost, many borrowers have difficulty refinancing because they have insufficient equity, mostly because the value of their properties has dipped below what they owe on the mortgage. Compounding this problem is the fact that in recent years, lenders and mortgage brokers offered creative financing strategies that allowed buyers to finance 100% of the purchase price. In those situations, even if buyers have paid down the mortgage, they still have little equity. And today, lenders are more strict about how much they’ll lend, usually requiring refinancers to have at least 5-10% equity in the home.
Another problem is that lenders have tightened lending standards for stated income loans. With stated income loans, borrowers don’t have to provide independent verification of their income. Instead, the amount they can borrow is based on the income they claim to have. These loans were intended for people who had a hard time verifying income, such as the self-employed. But in recent years, some borrowers used stated income loans to artificially inflate their income to qualify for bigger mortgages. Without increased income or equity, these borrowers will have a hard time qualifying for more traditional refinance mortgages for the same amounts.
Getting Help to Refinance in Today`s Market
You may need help to refinance in this difficult market. Consider the following options if you are looking to refinance.
Get help from a mortgage broker. If you’re considering refinancing, talk with a mortgage broker about your options — and do it quickly if the interest rate on your ARM is going to reset soon. Get all your paperwork in order, such as paystubs, W-2s, and bank statements. If you`re worried about your credit score, check it before speaking with a broker — he or she can more realistically help you explore your options.
FHA Secure. Even if you don`t qualify for a traditional refinance mortgage, you may be able to qualify for a program sponsored by the Federal Housing Administration (FHA) called FHA Secure. FHA Secure is available to borrowers who have defaulted on their ARMs when their interest rates reset.
To qualify, you must have good credit and at least 3% equity or cash in your home. (That means you can qualify if you’ve paid off at least 3% of your mortgage, even if the property`s value has dropped.) To qualify, your interest rate must reset between June 2005 and December 2009. Borrowers must have a history of stable payments prior to their loans resetting. For more information, visit the FHA website at http://portal.hud.gov (click on FHA Secure).
Shop around. Whether or not you use a mortgage broker, be sure to shop around for the best deal when you refinance.
To keep track of the information you collect on each refinance option, use Nolos eForm: Mortgage Rates and Terms Comparison. This handy worksheet helps you get all the important information, then compare rates and terms for each loan so you can choose the right one for you.