To Refinance Or Not To Refinance?

With mortgage rates at historic lows, many homeowners are mulling refinancing. And in this column, The Early Show financial guru Ray Martin says waiting could mean missing a historic window of opportunity. He also spells out refinancing options and ways to keep closing costs down.
Don't Miss This Window to Refinance

In 1958, Dwight Eisenhower was president, the cost of a U.S. postage stamp was four cents, the No. 1 single was "All I Have To Do Is Dream," by the Everly Brothers, "Gunsmoke" was a hit show on television, and a housing boom, fueled by young families moving into the suburbs and the GI Bill making it easier for veterans to get mortgages, was in full swing. The interest rate on a 30-year fixed rate mortgage was around 5.5 percent.

Fifty-one years later, much has changed -- except mortgage rates. In January 2009, the rate on the 30-year mortgage with no points is about 5.5 percent.

According to the Mortgage Bankers Association weekly survey, the average contract interest rate for the 30-year fixed rate mortgage is 4.89 percent, the lowest level recorded in the survey's history. The average contract rate for the increasingly popular 15-year fixed-rate mortgage is around 4.63 percent. To get the rates in the MBA survey, folks paid about 1.2 points. One point is one percent of the mortgage amount, so for each $100,000 of a loan, one point will cost $1,000.

Why are mortgage rates so low? In response to the unprecedented housing and financial crisis, both the Treasury and the Federal Reserve have injected over $100 billion into the mortgage-backed securities market since last fall. The Fed has stated that it may add up to $570 billion more this year. The result is that mortgage rates have dropped almost a full percentage point since this time last year. These actions, if fully rolled-out, would have the effect of creating a market for mortgages at low rates, keeping pressure on mortgage rates to the downside, and possibly driving mortgage rates lower.

While mortgage refinancing applications have been shoeing a strong increase, according to sources at mortgage lenders, many folks are still waiting around for even lower interest rates. Some are thinking the rate could go to 4.5 percent or lower, and are waiting to catch the bottom.

But homeowners who have a mortgage with a fixed rate of 6 percent or more need to get busy thinking through their refinancing options. Folks with adjustable rate mortgages should not miss this opportunity to lock in the certainty of a low fixed rate, even if their current rate is lower than the fixed rate.

Here is another thing to think about: If you wait to try to "catch the bottom" and, while you wait, your financial condition unexpectedly takes a turn for the worse (you lose your job, etc), then you may not qualify to refinance and could miss out on what could be the lowest mortgage rates in a generation of homeowners.

Another factor worth considering: the pressure on home values continues to be downward. It's advisable to refinance your mortgage now at your home's current appraised value, as opposed to risking a further decline in value.

Homeowners with larger mortgages should definitely look at refinancing again, even if they refinanced in the last year or two. The monthly savings from lower interest rates for larger mortgages are greater and can recover the costs of a refinancing transaction sooner.

The bottom line: Considering Refinancing if:

1) Your current fixed rate is over 6 percent, and
2) The savings created by your new lower payment recoups the closing costs in 24 months or less.

or

3) You have an adjustable rate mortgage set to adjust before you plan to sell the house.

Mortgage Refinance Options

Many homeowners falsely assume they would not benefit much from refinancing or that they cannot refinance because their credit is poor, their home's value has fallen too much, or they lack the cash to cover the closing costs.

First thing first: Refinancing options for folks who are unable to prove their income and assets with verified financial documentation and references will struggle to find any reasonable refinancing options.

Expect to be required to provide full documentation of income and assets with your mortgage application. These requirements will include three months of pay statements and at least two years of tax returns. Qualification requirements may also include having reserve assets equal to six to 12 months of mortgage, insurance and tax payments. In most cases, 70 percent of retirement account balances count towards this requirement.

But if you can provide documentation of the income and assets required, your credit score is 700 or higher, have no late payments, your mortgage loan amount is less than 80 percent, and the loan amount is not more than $417,000 (up to $625,000 in designated high-cost markets), then you'll have plenty of refinancing options available as your situation and mortgage will be "Conforming."

But what about folks whose mortgage and financial situation is "non-conforming"? There are mortgage products offered through Fannie Mae and Freddie Mac that accept folks with full financial documentation, credit scores of around 680, no late payments in the past year, and loan-to-value ratios up to 90 percent. Expect to pay an additional one-half of a percent in the form of a mortgage insurance premium.

Homeowners who do not qualify for these mortgage refinancing programs should consider refinancing options through the Federal Housing Administration. Folks who qualify with full documentation of income and assets, with credit scores of 580 (in some cases lower), one late payment over the past year and a loan-to-value ratio of up to 97 percent can find reasonable options here.

Tactics To Consider When Refinancing

No Cash Closing: If refinancing makes financial sense but you can't make the move because you are strapped for cash to pay closing costs, consider rolling the closing costs into the new mortgage. The result will be a slightly larger mortgage amount owed, but smaller monthly payments. Then use the savings to make additional payments against the mortgage to pay it down to the original balance.

You'll need to compare the monthly savings from lower payments to your closing costs to determine whether you will recover your closing costs before you sell your home or otherwise pay off your mortgage. If you haven't yet recovered the costs of your last refinancing, you'll need to figure that in, as well.

Look Out for Prepayment Penalty: Read your current mortgage note carefully to determine if any penalty applies for prepayments (paying off your current loan early). Typically, prepayment penalties can apply in the first three years and can be as much as six months interest on the original amount of the mortgage - on a $200,000 mortgage, that can be over $6,200.

Consider Escrow Services: If you've been paying property taxes and homeowners insurance directly, consider using the lender's escrow payment services: Often, lenders will offer a discount toward closing costs if you agree to use their escrow services for payments for taxes and insurance.

Avoid Mortgage Taxes: In some states, such as New York, a mortgage tax of half-to-three-quarters of a percentage point applies for new and refinanced mortgages. The way to avoid this cost for refinanced mortgages is to assign the mortgage to the new lender and have it modify the rate and term to conform to the new mortgage terms the lender is offering.

Go with 15-year and Save: If your ultimate goal is to save money over the life of the loan, consider a 15-year mortgage. Interest rates for 15-year fixed-rate mortgages are around 5 percent; or half-a-percentage point lower than rates for 30-year mortgages. Since the mortgage will be paid off over 180 months, the payments will be more, but the savings are considerable.

Homeowners who like the savings of the 15-year mortgage but need the flexibility of the lower payments on the 30-year mortgage can accomplish almost the same results by taking out a 30-year mortgage but making the larger payment required for a 15-year loan. If you do this, you can pay off a 30-year mortgage in about 16 years. If cash flow gets tight, you can fall back to the lower payment required by the 30 year mortgage, and increase payments later when you can afford to.

Refinance to Fixed Rate Mortgage: For folks with ARMs, it's wise to refinance to a fixed rate mortgage where the payment will be higher but never changes, rather than continue with an ARM and deal with the inevitable shock of a payment that is even higher. But be careful to check the current mortgage for additional fees that may apply during a pre-payment period, which could be up to three percentage points of the mortgage amount.

Avoid Jumbos: Interest rates have risen significantly on the upper end of the mortgage market. The rates for the so-called jumbo mortgages -- those exceeding the $417,000 amount (up to $625,000 in designated high-cost markets) eligible for purchase and guarantee by Fannie Mae and Freddie Mac -- are two or more percentage points higher than rates for loans below this limit. That means that the monthly payment for a $418,000 mortgage as opposed to one just $1,000 lower, or for $417,000, would be more than $550 per month! If you are close, but over, the conforming loan limits for your area, consider using other sources of cash on hand to pay down your mortgage to the conforming amounts to qualify for a lower rate.

Shop Several Mortgage Brokers: With the rapidly changing mortgage marketplace, the options available can vary widely from one mortgage broker to the next. There has been a shakeout in the market, and only those with strong backing of large lenders or with good contracts with Fannie Mae or Freddie Mac will have the best options during this period of change and uncertainty.

Consider Rate Locks: Some lenders are offering a rate discount if you agree to a 45 day rate lock. That means the rate they quote today is committed for 45 days, which gives them more time to approve and process your loan. While this sounds like a nice thing to do, lenders are not offering this out of the goodness of their hearts. Their thinking is that rates are likely to trend lower still, and if they are right, they will earn an additional fee called a "yield-spread-premium," which is based on the difference between the rate you locked into and the rate for mortgage-backed securities when they package and sell your loan to investors.

Consider Refinancing Alternatives: Some mortgage lenders are offering alternatives such as loan modification, in which the lender offers to change your current mortgage rate from an ARM to a fixed-rate loan for a fee of a few hundred dollars. While the interest rate might be slightly higher than what you could get if you shopped around for a new mortgage, the savings in closing costs can make up for this.

Also, folks with FHA mortgages can ask about their Streamlined Refinance program, in which the paperwork, appraisals and documents from your prior mortgage can be used to reduce the closing fees and processing time.