With interest rates on 30 year fixed-rate mortgage loans falling below 4%, the lowest level since the 1950s, many borrowers are keen to refinance their home loans and other mortgages. By any long-term measure, current rates are a great deal and could result in tens of thousands of dollars in savings over the life of the mortgage. However, getting these low rates (and big savings over the long term) is not so straight forward. Most banks are much stricter on their lending criteria and only those with excellent credit and equity in their homes will get access to these record low rates. Here are the some of the main considerations and hurdles you think about when refinancing your mortgage:
You must have a Credit Score greater than 720
To get the lowest loan rates, you’ll need an excellent FICO credit score (720 or higher). You should obtain your credit score before you apply for a mortgage from FICO itself or at one the three main credit bureaus: TransUnion, Equifax or Experian. (Note: Your annual free credit report from www.annualcreditreport.com, does not give you your credit score).
Once you’ve received your credit reports, check them for errors that could hurt your score. Make sure you contact the agencies and credit bureaus if you notice any errors so that they can get fixed, which can result in an improved credit score. If you have large credit card balances, you can raise your score quickly by paying them off. Your “credit utilization” ratio, which reflects to the amount you’ve borrowed as a percentage of your available credit, accounts for 30% of your credit score.
Must have at least 20% home equity
Ideally, you should have at least 20% equity, based on your home’s current appraised value (not what you bought it for). If your home has dropped in value, and your loan is greater than the value of your home (i.e. you are underwater on your home) you will almost certainly be unable to refinance
Homeowners with less than 20% equity may still be able to refinance, though the cost of doing so may be higher because of the need to buy private mortgage insurance (where available). Private mortgage insurance protects lenders against default, but the cost of obtaining this insurance may wipe out any savings from refinancing.
Investment homes are also much more difficult to refinance, even if you have 20% equity in them. Some reports say banks are asking for as much as 50% equity in order to refinance investment properties, on which loan rates are almost half a percent higher then home mortgages. Which means that unless you plan to hold the investment for a 10 year plus time frame, the cost of refinancing may not be worth it.
No other mortgages or lines of credit
If you have a home equity loan or line of credit, you’ll probably need to pay it off before refinancing, which means you need to do a cost/benefit analysis of whether refinancing makes sense for you. Before a lender will refinance your first mortgage, it typically needs approval from the lender that holds your second mortgage. The lender with the second must agree to “subordinate” the loan, which means it will take second place behind the new first mortgage. However, due to the credit crisis many lenders are refusing to subordinate their loans – making refinancing hard for a number of people who used their home as an ATM (line of credit) during the boom times.
The other thing to consider with your mortgage is whether it is above or below the national conforming limit amount - $417,000. The lowest rates are limited to the conforming loans because government-sponsored mortgage giants Fannie Mae and Freddie Mac will buy them in the secondary market. That makes those loans less risky for lenders. In some instances, Mortgage GSE’s Freddie and Fannie also will purchase loans above the conforming limit (per recent legislative changes), but these will have higher rates due to the higher cost of insuring them against default.
Borrowers may satisfy the above points, but still may not qualify for the lowest rates, because the interest rates for loans that exceed the conforming limit (known as jumbo loans) have remained high. The average jumbo rate for loans greater than $625,000 is about 1 to 2 percent higher than conforming loan rates, according to Bankrate.com.
Employment & Other Factors
With the tough economic environment, many lenders are also being much more critical in verifying income and one’s employment situation. If you are in a job within a shaky industry or is “at-risk” according to bank classifications you may get knocked back when looking to refinance your home. Also, if you are planning to move or even pay off your loan within the next few years, refinancing probably makes little sense because you won’t be paying monthly bills long enough for the savings to cover the refinancing costs.
Finally, it make take time to actually process your refinancing request. In a normal market, refinancing makes up 50% to 60% of a mortgage broker’s business. However, with new loans drying up, for many brokers 90%+ of their business is now refinancing and with the stricter criteria in place, it may take much more time to get the necessary approvals. So have patience and keep working on building your credit score and home equity while you wait.
When is Refinancing worth it?
Generally speaking, if you can earn the refinancing costs (normally 1%-3% of the loan value) back within two to three years, and it’s a home you’re prepared to stay in for much longer than that, it’s usually a good option to refinance your mortgage. From a risk perspective if you have an adjustable rate mortgage, refinancing to a low 30 year fixed rate may also be a good idea because it will ensure your repayments never skyrocket and place you under financial duress.
Also, never blindly trust mortgage brokers who will give you life-of-loan refinance savings calculations that may not factor in the taxation implications (mortgage interest is tax deductible). Also, consider the opportunity cost of refinancing. Could you make more by putting that money into other investments? You can search on-line for a number of refinancing calculators and do the numbers based on your own personal situation. So do your homework before looking to refinance and like any financial product or service always shop around to get the lowest fees and best rates