Refinancing? 7 Things You Need to Know

(MoneyWatch)  Record-low interest rates have millions of Americans considering refinancing their mortgages. But falling home values, declining credit scores and reluctant lenders have created a tricky lending market.

Here are 7 things you need to know if you want to refinance today.

Your Score: Those "easy-qualifier" loans of yesteryear, available to anyone with a pulse, are long gone. Now if you want a good loan, you need a good credit score. The best deals are reserved for those with scores of 740 and above. If your score drops below 700, you might have trouble finding a lender willing to offer a mortgage at any price, said Keith Gumbinger, vice president of the mortgage research site HSH.com.

Because there are some non-refundable up-front fees -- a few hundred dollars to pay for appraisals and credit reports -- with most mortgage loans, you probably shouldn't apply unless you're pretty certain you have a good enough score to qualify, he said.

Your Equity: The biggest hurdle to refinancing for many homeowners, however, is equity. With home values still falling in many parts of the country, that 20% down payment you made three years ago could have evaporated, leaving you with more mortgage debt than your house is worth. If that's the case, you can turn to a government loan program called HARP, said Greg McBride, financial analyst with BankRate.com. HARP, short for Home Affordable Refinance Program, is available to those who have little or no equity. But the loans are notoriously difficult to get.

If you can't qualify for HARP, you're likely to need at least 20% of equity in your home, McBride said. Equity is the value of the home, minus any loans or liens against it. You can get a guesstimate of your home's value at real estate sites, such as Zillow.com. Zillow's "Zestimates" are not appraisals, but they are likely to give you a ballpark value before you attempt a refinance.

Your Debt Ratios: Can you afford the loan? Your reply is probably "Of course" because cutting your rate is likely to cut your payments and you could afford the old payments, right? But lenders answer this question based on your debt ratios not the payments you've made in the past.

To qualify for a refinance, your new mortgage payment, including taxes and insurance, should amount to less than 30% of your gross monthly income. Additionally, your total debt payments (including car, credit card and student loan obligations) should amount to less than 40% of gross income. (Gross income is the total amount you earn, before income taxes and other deductions are taken out.) You'll have to provide documents, including tax returns and pay stubs to verify that your gross income is what you say it is, too.

Liens and Seconds: Another thing that could knock your refinance out of the box are second mortgages, said Gumbinger. That's because refinancing pays off your first mortgage, putting the holder of your "home equity line of credit" first in line to be repaid. For a refinance to go through, the HELOC lender must agree to "subrogate" its interest, essentially moving back to second-place in the repayment order. And lenders are getting reluctant to do that in today's market where so many banks have lost so much to foreclosure, he said.

Your Timing: The rate for 30-year fixed mortgages, which serves as an industry benchmark, is running at about 4.6% today, said McBride. But you can get an even cheaper loan if you're willing to go with a hybrid Adjustable Rate Mortgage that offers a fixed rate for five years. The catch: If you're going to stay in the home for more than five years, you could face significantly higher interest rates and monthly payments in the future, said Gumbinger. These cheap 5/1 ARMs could save you thousands if you move or repay the loan before the fixed period is up, he said. But only consider them if you're certain you can do that and are able to handle the risk if you don't.

The APR: Want a lower rate, which means a lower monthly mortgage payment? You can probably get it by paying higher fees. But that's not necessarily a bargain. Lenders consider rates and fees to be at the opposite ends of a refinance teeter-totter, said McBride. If you want one to come down, the other is likely to go up. To make apples-to-apples comparison of the total costs, watch the Annual Percentage Rate, which factors in both the fees and the interest rate.

Lower Payments Don't Always Equal Lower Costs: Even if you cut your mortgage payment and interest rate, you might end up paying more overall if you stretch out the repayment terms. To illustrate, consider somebody with a $300,000 balance on a 5.5% loan that only has 20 more years to go. That balance, amortized over 20 years, would result in monthly mortgage payments of $2,063.66, or $495,278 total.

If this borrower got a new 30-year fixed-rate at 4.6%, his payment would drop to $1,537.93, but he'd be paying an extra 10 years. Total cost: $553,654 --$58,378 more.

The Federal Trade Commission publishes a mortgage shopping worksheet to help you compare refinancing offers from different lenders.

More on MoneyWatch
4 Steps to Get Your Finances on Track
Top 5 Investment Scams
Money-Saving iPhone Apps
6 Things You Should Never Reveal on Facebook