A Homeowner's Step-by-Step Guide to Making the Recession Pay

If you've got equity in your home and a job, you should love this recession. It could make you thousands of dollars richer. That's because it's pushed rates for "conforming" loans -- those under $417,000 -- to near record lows. And despite moans to the contrary, if you're a creditworthy borrower, these loans are pretty easy to get.

A Northern California reader brought this to my attention with a simple question: Should she refinance her home or pay it off faster by tossing a few hundred dollars more into each monthly mortgage payment?

The wise answer -- for those who can afford it -- is both. It can literally save you thousands of dollars and drastically reduce your personal inflation rate over time. Putting your personal inflation rate in check is important for those of us who think today's government spending spree is going to prove inflationary. (I was alive in the '70s and remember inflation. It's even uglier than bell-bottoms. But I digress.) My curious reader, Tricia, would save more than $90,000 by taking this advice. You can save a fortune too.

Want to see how to save? Let's follow Tricia's story to illustrate the steps and show how to do the mortgage math.

Like about 90 percent of the workforce, Tricia still has a job. Like many of the people who didn't buy at the peak of the bubble, she has plenty of equity in her home, too. Better yet, she's always been responsible with money, so she's got a great credit score. That means she can refinance at today's best rates.

Right now, she's got a $141,000 mortgage, which is at a 5.78 percent fixed rate. Monthly payment: $825.53. She can afford more and has been paying an extra $300 per month -- a total of $1,125. This wise move will already save her a small fortune by allowing her to pay off her mortgage in 193 payments instead of 360, which cuts her total cost of the loan from $297,000 to $217,125, a tidy $79,875 savings.

But what if she refinances to a lower rate and continues to pay the $1,125 each month? She saves another $16,000.

Let's go step-by-step.

A quick check to loan-shopping site BankRate.com told me that she could find a loan for 4.75 percent with Wells Fargo Bank (this was on April 10th, which I note because rates change daily). She'd have to pay up to one "point" -- that's one percent of loan amount -- in fees. The site doesn't say this, but she'd face additional costs for a home appraisal, title insurance, credit checks and "processing." Mortgage experts tell me that it's not unusual for total closing costs to amount to two percent of the loan amount. In this case, we'll assume she pays $3,000.

To make the cost saving analysis fair, we're going to assume that she adds the $3,000 in closing costs to her loan balance. (This is fair because it accounts for interest on the refinancing fees. Whether she pays the closing costs in cash or finances them, she'll have an interest cost because she, at minimum, no longer has that much cash to invest.)

So, now, she's got a $144,000 loan at 4.75 percent. To figure out her monthly payment, we go to the nifty mortgage calculators at MortgageGrader.com. That tells us that the required monthly payment on this loan is $751.17.

Tricia, however, is still going to pay the $1,125 that she can afford. Another calculator at the same site figures how long it will take to pay off a loan when you consistently pay more than you must. Plugging in Tricia's numbers, we see that the $1,125 payment allows her to pay off the $144,000 mortgage in 14 years and 11 months -- 179 payments. Total cost: $201,375. From start to finish, she's taken her mortgage cost from $297,000 to $201,375, resulting in $95,625 in savings.

Great deal, if you can get it. Can you?

Here's what it takes to qualify for a great mortgage these days:

  • Equity: You need at least 20 percent and it's better to have 30 percent or more. An easy way to get a ball-park estimate on your home's value is to look it up at Zillow.com. The web site's "zestimates" are not full appraisals, but give you a decent read and the site can allow you to see recent home sales in your area.
  • Income: You need to be earning enough so that your mortgage payment, including property tax and insurance, is below about 35 percent of your gross income. This figure varies lender-to-lender, and can go higher if you're very high income or have no other debt. The main issue: The lender needs to know that you can make the monthly mortgage without breaking a sweat.
  • Credit score: If your score is under 700, fix it or don't bother. Lenders are only giving low-cost loans to people with long histories of paying their debts on time and in full.
  • Work history: A stable job, with a long work history helps. If you're self-employed, lenders are going to ask for at least the past three tax returns to make sure you've got a steady-enough income to make the payments.
  • Savings: Money in the bank is a safety net for you, and your lender is going to look at it the same way. The less you need a loan, the easier it is to get one.
Beware! Some lenders will encourage you to apply for a refinance loan when you don't qualify or when you're pretty sure you're on the razor's edge. Don't do it. They're encouraging you because they charge up-front fees that are not refundable. Lenders have strict standards today. If you can't meet them, paying an upfront fee is throwing your money out the window.