Published April 10, 2012
With interest rates holding steady near record lows, homeowners have a lot of incentive to refinance their mortgage.
The national average for a 30-year, conventional, fixed-rate mortgage was 3.98% as of April 5, according to Freddie Mac. But experts warn not to expect rates to stay so low as the economy continues to improve.
“The most important factor is how much incentive a borrower has when they compare current rates with their existing mortgage rate,” says Michael Fratantoni, vice president of single-family research and policy development at the Mortgage Bankers Association. “For most borrowers, if rates drop as much as 0.50%, it can be worthwhile to refinance.”
Depending on a homeowner’s financial goals, they can save thousands of dollars in interest payments or increase their monthly cash flow by refinancing. But the mortgage and refinancing process has become more stringent since the 2008 financial collapse.
“The best thing someone can do is prepare a lot of documentation,” says Joseph Pigg, vice president and senior counsel for mortgage finance at the American Bankers Association. “Expect the process to take a lot longer than it did a few years ago.”
Experts suggest focusing on every area of the application process as you maneuver through your mortgage refinance.
Check your credit score. “Having a FICO score greater than 740 qualifies a borrower for today’s lowest interest rates,” says Keith Gumbinger, vice president of the mortgage blog HSH.com. “You can get a loan with a FICO below 720 but there are add-ons for sliding down the credit scale.”
Rod Griffin, director of consumer education at credit reporting company Experian, suggests getting a copy of your credit report three to six months before the refinancing process. “By addressing the risk factors, you can improve your credit history and, ultimately, your credit score.” Getting a copy before you apply is important because improving your credit score can take three months or longer depending on how serious the issues are. When you work with one credit bureau, generally the others will get that same information, he adds.
Shop the marketplace. Gumbinger recommends talking to at least six lenders about rates, terms, and fees to get a sense for what loans are available for your credit score, loan balance, and house value.
“Start locally, especially in areas with a challenged market, as a local lender might be more knowledgeable and better suited to make your transaction easier,” he says.
Decide whether to pay fees upfront. Closing costs on a mortgage cover points, appraisals costs, and closing fees and are calculated as a percentage of the mortgage balance. In general, fees are 2% of the mortgage balance. “You can pay them out of pocket, incorporate fees into your equity if you have equity by taking a small percentage of cash out, or take a slightly higher interest rate,” says Gumbinger. “Most cash outs are not in excess of 80% today.”
Borrowers living in their homes for at least a year may be eligible for a mortgage with a higher interest rate and no points paid upfront, says Frank Donnelly, president of the Mortgage Bankers Association of Metropolitan Washington. “You won’t lower your pricing as much as if you paid more upfront in points but, if you’re in the house for a short period, it may make more economic sense to take a higher interest rate with no closing costs rather than paying points or high closing costs upfront.
Decide either a fixed or floating rate. Borrowers should know their risk tolerance and time horizon for staying in their house, says Donnelly. “If you know that you’re going to move in five years, it might make more sense to get a loan that adjusts in seven or 10 years (7/1 or 10/1) instead of a 30-year fixed rate loan.”
Know what you can afford. “A new 30-year fixed-rate loan can help your monthly cash flow,” says Gumbinger.
Borrowers looking to pay down their mortgage faster should consider a 15-year or 20-year loan that would have a payment similar to the existing loan’s payment.
Lock in your rate. Experts advise borrowers to lock in their rate when they apply for the mortgage. Since most refinances take 60 days from application to close, Gumbinger suggests asking if your loan will take longer to close.
“Select a commitment period and rate lock that covers that time period,” Gumbinger says. If you believe rates will fall, ask about a float-down option that can cost up to 0.25% of your mortgage balance. Know the market trends and weigh the cost and trigger provisions, or how much the rate has to fall for you to benefit from a lower rate, against the likelihood of rates falling, says Gumbinger. “When interest rates increase, if at the end of your commitment period your loan hasn’t closed, ask if your rate lock can be extended, under what conditions, and for how long.”
Be prepared. Lenders generally want to see three to 12 months of a borrower’s paystubs to verify income and employment, one to three years of a borrower’s tax returns and W-2s, and up to 12 months of a borrower’s bank statements to verify assets, says Reed Piano, managing director at the National Association of Mortgage Underwriters.
Self-employed borrowers may be asked for information like business models and projections, for example, showing their business is solid. “More information doesn’t hurt,” he adds. “The underwriter wants all this paperwork so they know who this borrower is.”
Know your home value. Since home prices are highly variable and continue to fall in some markets, lenders want well-supported property valuations. Experts agree that a knowledgeable homeowner can help an appraiser accurately value their home.
“A homeowner should be present when the appraiser is doing the inspection,” says Sara Stephens, president of the Appraisal Institute. “You’re the best piece of information about your home.” She recommends that homeowners prepare a written list of the home’s amenities and dates of any upgrades and repairs, such as new roofs, kitchen upgrades, or when insulation was added to an attic, for example.
Appraisers base your house’s value on the comparable sales of neighboring properties. “Look around at real estate sites like Zillow to get an idea of appraisals and valuations in the area for comparable homes,” says Pigg. “Education yourself about what’s comparable to help set expectations or argue for a better appraisal if you can show that good comparables weren’t used.”
If the appraisal value is below what you expected, experts recommend reading the appraisal to see whether it reflects the actual square footage and amenities in your house. Stephens suggests looking at the online county tax assessments for each comparable to check whether they’re located in your neighborhood and similar to your home. “If you’re totally dissatisfied, make that clear to the lender and ask about the possibility of hiring another appraiser,” says Stephens. Make the case why you think the appraisal isn’t accurate and ask how old the comparable sales are and why they were picked, as well as why any comparables that you provided weren’t used, she adds. “Appraisers are gatherers and users of data. Anything a homeowner would give us is certainly a plus.”