Mortgage Rates Fall: 5 Rules for Refinancing

Last Updated Jul 15, 2011 12:20 PM EDT

Interest rates continue to defy expectations and fall ever lower, creating another opportunity for homeowners to lock in record-low mortgage rates. For people in the most expensive real estate markets who want mortgages of $700,000 or more, this could be the last chance to capture the lowest rates.

But before you get started on a refinance, you should know that the mortgage market remains dicey. If you want the best loans at the best prices, the are five things you need to know:

1. Your score: Lenders are giving the best rates to people who have a combination of high credit scores and plenty of equity (more on that in a minute). If you're contemplating a refinance, check your score. To get the best rate, you want to be at 740 or above.

Every 20 points that your FICO score drops below that number will cost you money, Gumbinger adds. At 720, you should figure that you'll pay about 0.5% more in points. (Points are up-front fees calculated as a percentage of your loan amount); at 700 you'll pay about 1 percentage point more in fees to get the loan.

If your score is below 700, in addition to the up-front fees, you're likely to pay about 1 percentage point more in interest. The bottom line: A loan that would cost the best borrower 4.5% will cost the less credit-worthy borrower 5.5%, plus 1% in points. On a $250,000 loan, the dollar-and-cents impact of that difference is a whopping $52,400.

Boosting your FICO score by 20 points isn't that difficult, if you know how. Check out this post, if you want some tips.
2. Your equity: Again, if you want the lowest rate, you need a lot of equity -- borrowing 75% or less of the home's appraised value. If you borrow more, expect to pay one "point" in costs. That will cost you $2,500 on a $250,000 loan.

3. Appraised value: Having sufficient equity is particularly tricky right now because lenders have become extremely cautious with appraisals. You should expect the appraisal on your property to come in far lower than it did the last time you refinanced. In fact, many Realtors maintain that prices are currently at 2003 levels. If you don't remember what that number might be, you can check Zillow for a "zestimate." If your house is in great shape, this estimate will be low; if it's not, it could still be a little lofty, but it will at least get you in the ballpark so you can figure out whether you have enough equity to get the best rate. The answer can suggest whether pursuing a refinance is worth your time.

4. Go long: In today's suddenly debt-averse market, many homeowners are refinancing into shorter-term mortgages, such as 10 and 15 year loans. Don't do it. You get a slight break on the price by shortening the term of the loan, but you give up a ton of flexibility. If you want to pay off your loan in less time, you can simply make bigger payments on your 30 year, fixed-rate mortgage whenever you can afford to. But if you take out a 15-year loan, you're obligated to make those bigger payments. If you can't afford the larger payments with a 15-year loan one month, you're stuck when you have the shorter-term loan. The slightly higher rate for a 30-year loan is a small price to pay for long-term flexibility.

5. Negotiate your fees: Every time you take out a new loan, you pay a bunch of little nagging fees -- escrow, document preparation, wire fees, etc. The biggest of these costs is for title insurance. Your lender is likely to suggest a title insurer that's connected with the bank and it's highly unlikely that this company is going to give you the best rate. For more on how to shop around, check out Re-fi Rip-offs: How to Cut Junk Fees.
Kathy Kristof is the author of Investing 101.
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