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How to tell whether now is the time to refinance

A sharp drop in mortgage rates has sparked a wave of refinancing. But not everyone qualifies. Here is a guide on whether refinancing might be a good option for you.
30-year fixed mortgage rates chart
The sharp drop in mortgage rates has sparked a wave of refinancing. But not everyone qualifies.
/ Source: contributor

When Elaine Chen, a 39-year-old marketing executive in New York, saw interest rates falling in January, she called her mortgage broker to see if she could get a lower rate to finance Manhattan condo. She estimated the lower rate could save her $300 per month. 

Her broker said she could get a 5.625 percent rate on a 30-year, fixed-rate mortgage if she hurried and paid $5,000 in closing fees. But Chen, suspecting that rates would fall more, didn’t bite. By the time rates fell further, she couldn’t get her busy broker on the phone.

“I never heard back from him,” she said. “I still haven’t decided what I’m going to do. I’m not sure I can act fast enough to catch the best rates.”

Ted Woelken, a 51-year old telecom manager in Sammamish, Wash., said he and his wife decided against refinancing their adjustable rate mortgage, which is not due to reset for two more years. To justify moving to a 30-year fixed loan, Woelken said they would need to get 5.1 percent rate rather than the 5.4 percent rate their lender offered.

“When you have a first and second mortgage, just because rates on 30-year fixed loans are coming down doesn’t mean you’ll benefit right away by converting,” he said. “We have two more years below 5 percent, so we’ll wait and look again.”

Chen and Woelken, like many borrowers, are finding that their options aren’t as attractive as they’d expected. They’re lucky though. With full-time jobs, good credit, and more than 20 percent equity apiece in their properties, refinancing is largely a matter of optimizing affordable loans. Other borrowers with spotty credit or job histories, and those facing adjustable rate mortgage resets or living in a home that’s lost value, will have a harder time refinancing and may face difficult repercussions for failing to do so.

Wondering if you can refinance? Here’s a look at possible scenarios:

You can consider refinancing if ...
You have a fixed or adjustable mortgage with an interest rate over 6 percent.
With rates on 30-year fixed loans below 6 percent, many homeowners want to lower monthly payments or move from an adjustable to a fixed mortgage. You’ll need to run numbers to see if closing costs justify the new rate’s monthly payment savings, but many lenders say that if you can save 50 basis points (0.5 percent), or even 25 basis points with no closing costs, it might be worthwhile.

Your credit score is over 650. To get a good rate on a non-government loan, your score needs to be at least 650 — maybe 680, depending on the lender and market. It’s worth pulling scores before approaching lenders, as scores help determine your rates.

You live in an expensive urban market and have a mortgage over $417,000. Government-set maximum limits on conforming mortgages, previously capped at $417,000 in most markets, will rise starting in March to $729,750 in California and other pricier markets. If your loan exceeds $417,000, you could refinance from a “non-conforming” to a more desirable “confirming” loan.

Dick Lepre, senior loan officer at Residential Pacific Mortgage in San Francisco, says he expects more than 50 percent of mortgage loans in California have balances that fall in the new, higher  range, and thus his state will see what he called “a massive refinancing boom.” Dave Zitting, chief executive of Primary Residential Mortgage in Salt Lake City, agrees, saying: “It’s going to fend off a recession.”

You’re eligible to refinance to an FHA loan. Loans offered by Federal Housing Administration, typically targeted at first-time or smaller-budgeted buyers, are usually offered to people buying a property priced below a local market’s median price. New rules going into effect in March are lifting FHA lending limits to 125 percent of median prices in a local market (up to $729,750 in some markets) and will help many borrowers, says Bob Walters, chief economist for Quicken Loans.

Bill Glavin, special assistant to the FHA commissioner, says FHA refinance loans don’t have strict credit score criteria and those who use them can qualify with as little as 3 percent equity in their property —even in a so-called “declining market” where other lenders demand more equity.

You have at least 10 percent equity in your home and aren’t FHA-eligible. To get good rates, you’ll need to have equity in the home. In most markets, 10 percent equity is a minimum. In more volatile markets like California, lenders want to see as much as 30 percent equity, says David Zugheri, president of First Houston Mortgage, which lends in Texas, Florida and California. If you have minimal equity but have poured work into your home, an appraisal may reveal that remodeling has increased your home value sufficiently to create the equity you need. 

It may be unwise or difficult to refinance if ...
Your interest rate on a fixed loan is below 6 percent or you plan to move soon.
Many lenders say closing costs related to a refinance aren’t worth it if you’re shaving less than 50 basis points (0.5 percent) off your current interest rate, or 25 basis points with no closing fees.

Planning to move? That makes refinancing a tough call. Even if you lower monthly payments, those savings may not offset by the closing costs required for a new loan. Your lender may offer a rate modification—a lowering of interest rate without a full refinancing. Borrowers with mortgages at ING Direct, for instance, can pursue a rate modification to ING’s lowest available rate for free or a maximum $500 fee (depending on timing of your refinance) says Bill Higgins, chief lending officer at the Delaware-based online bank.

Your credit score is below 650 or your credit report has blemishes. Unless you’re eligible for an FHA loan, a low credit score means you may not get a favorable rate without substantial equity or other offsets. Refinancing options exist for borrowers with lower credit scores, but they come with price penalties that may not be worth it, such as a requirement to buy mortgage insurance, says Quicken’s Walters.

You have less than 10 percent equity in your home. Whether you used a low down payment to purchase or live in a market where home prices have fallen (taking some of your home equity), chances are you’ll have a tough time finding a refinancing situation that makes sense—or where you don’t have to bring extra cash to closing to create the equity required for the deal. FHA loans are an option, but eligibility depends on your home’s value relative to median market values.

You live in a “declining market.” Lenders have designated many areas of the country “declining markets” for risk purposes, meaning if you choose to buy in such an area (think Florida or California) your refinanced mortgage will require a down payment that’s higher than the lender’s normal minimum requirement—for instance, 15 percent vs. the usual 10 percent. When refinancing in a declining market, your may need to bring prohibitively large sums of cash to closing to “buy up” a minimum level of equity in your home and get your new loan approved.

You’re self-employed or want to pursue a “stated income” or “no-doc” loan. So-called “stated income” or “no-doc” loans grew popular with self-employed folks during the housing boom. It’s possible to refinance out of a stated-income loan to a regular product now, but forget securing a new stated-income loan. Self-employed workers now must provide extensive documentation.

You’re facing foreclosure. If you’re over 30 days late on mortgage payments, you’ve kick-started the foreclosure process and are technically in pre-foreclosure; if you’re more than 90 days late, you’re definitely in foreclosure. Late payments rob you of the power to refinance, but you may be able to get a “workout” with your lender in which you amend loan terms temporarily or permanently so you can get (and stay) current on your mortgage.