Keith Gumbinger
Keith Gumbinger, vice president of New Jersey–based HSH Associates, which publishes consumer loan information. HSH.com
With mortgage rates at record lows, this seems like a perfect time to refinance—except for the fact that many home owners are having a tough time qualifying.
Lending standards have tightened greatly, making refinancing a challenge for home owners with less-than-stellar credit ratings or high debt-to-income ratios. And depressed home values have left many home owners with insufficient home equity to qualify for refinancing.
But don’t give up on today’s amazingly good home mortgage deals—because there are solutions. How to clear today’s major refinancing hurdles…
In order to qualify for refinancing, your home’s value typically must be appraised, and often nowadays the appraised value is so low that you end up with dramatically less equity in your home than you thought you had. The home’s value even may be lower than the balance on your existing mortgage, leaving you “underwater.” Lenders typically won’t issue a refinance loan unless you have at least a 10% equity stake—meaning that you don’t owe more than 90% of the home’s value. A 20% equity stake typically is required to avoid paying private mortgage insurance (PMI).
What to do: There are four potential solutions if an appraisal suggests that refinancing (or refinancing without PMI) is impossible…
Get a second appraisal. Ask the lender for a copy of the appraiser’s report. It might be worth challenging the appraisal by paying for a second appraisal with the same lender if the lender is willing. Or you could shift to a different lender and get a new appraisal.
Using a second appraiser might be especially worthwhile if the first appraiser fell just short of the required value and if he/she failed to account for substantial improvements that you made to your home…or if he based the appraisal value largely on the sales prices of foreclosed or distressed homes or on homes in neighborhoods significantly less appealing than yours. This is not a step to take lightly, however—you’ll typically have to pay $250 to $500 for a second appraisal.
Helpful: If you believe that the original appraisal was flawed because it failed to properly account for the desirability of your neighborhood, ask your lender to select an appraiser based closer to where you live. This appraiser might better understand what the homes in your area are worth.
Do a “cash-in refinance.” Home owners who have sufficient cash can pay down their mortgages to reach the required equity levels.
Warning: If you have a second mortgage, you might have no choice but to pay this off to refinance.
Refinance through the Home Affordable Refinance Program (HARP). If your mortgage is owned or guaranteed by Fannie Mae or Freddie Mac, the most recent version of the government’s HARP program might allow you to refinance even if you are underwater or you have a limited equity position. The Web site www.MakingHomeAffordable.gov can help you determine if your mortgage qualifies (select “Does Fannie or Freddie Own Your Loan?” from the “Tools” menu). If so, contact your mortgage servicer and ask if it is taking part in the HARP program. If your servicer is not taking part, you’re allowed to refinance through a participating lender.
Refinance through the National Mortgage Settlement. If your underwater mortgage is owned and serviced by Ally Financial, Bank of America, Citigroup, JPMorgan Chase or Wells Fargo, you might qualify for refinancing through a settlement that those mortgage issuers made earlier this year with government regulators to make up for questionable foreclosure practices. To be eligible, you must have a current interest rate of at least 5.25% and no late payments within the past 12 months…the property must be owner-occupied and underwater…and the new loan must slash at least $100 per month or be at least one-quarter of a percentage point lower than the borrower’s existing rate, among other requirements. Contact your loan servicer for details if you think you might be eligible.
It’s possible to refinance with a FICO credit score as low as 620—but don’t expect to be offered attractive refinancing terms these days unless your credit score is 740 or above.
What to do: Purchase a copy of your FICO credit score from MyFICO.com for $19.95, which includes a score and credit report based on information on file with one of the three main credit-reporting bureaus.
If your score is about 740 or lower, obtain copies of your credit reports from the three reporting bureaus—Equifax (www.Equifax.com), Experian (www.Experian.com) and TransUnion (www.TransUnion.com). Then contact those bureaus to correct any inaccurate information on the reports. Avoid running up big credit card balances, making payments late or applying for new credit in the months before applying to refinance a mortgage. Pay down credit card balances and other debts if possible.
If you cannot increase your credit score to 740, a Federal Housing Administration (FHA) mortgage might be the only way to refinance at an attractive rate. FHA-refinanced mortgages officially are available to those with credit scores as low as 580, but in practice, lenders make them difficult or expensive to obtain for home owners whose credit scores are below 620. Contact local mortgage lenders that deal with FHA loans for details (select “Lender Locator” from the “Resources” menu at www.HUD.gov).
Five or six years ago, mortgage lenders considered a person’s total debt-to-income ratio of 55% or even 60% sufficient to refinance—and many lenders often didn’t even bother to confirm borrowers’ income. These days, a ratio no higher than 38% is likely to be required—a small percentage of lenders will go as high as 41%—and every element of the borrower’s financial situation will be scrutinized.
What to do: First, determine the ratio of your monthly debt payments to your monthly income, either using an online calculator (type “debt-to-income ratio calculator” into a search engine) or by asking a lender for help. If you’ve been paying down your mortgage for many years without borrowing against the value of the home, your debt-to-income ratio might not be as high as you fear. If you are slightly above the 38% mark, it might make sense to use liquid assets to pay down your debts enough to qualify for refinancing.
Lenders’ recent emphasis on income verification can make refinancing particularly difficult for the self-employed. For these home owners, the best option often is refinancing through a credit union or community bank with which they have a long-standing relationship.
Among those who should attempt to refinance…
Home owners currently paying 5% or higher. Fixed rates recently averaged below 3.7% for a 30-year mortgage. If your mortgage rate is 5% or higher, you’ll almost certainly save money by refinancing—unless you sell the home in the next year or two. If you’re paying between 4.5% and 5%, refinancing might be worthwhile, particularly if you expect to remain in your home for at least five years. A refinancing calculator such as the one on HSH’s Web site (www.hsh.com/refinance-calculator) can help you crunch the numbers.
Those who need improved cash flow today. Refinancing to a new 30-year mortgage can lower your interest rate and stretch your payments out over a new 30-year period. That could reduce your monthly mortgage bill by hundreds of dollars.
Those who want to build equity and pay down their mortgages fast. You don’t have to opt for a new 30-year mortgage when you refinance—you could choose a 20- or 15-year mortgage instead. Rates on these shorter mortgages are even lower than those available for 30-year mortgages—recently averaging just 2.95% for a 15-year fixed mortgage—which means home owners might be able to pay off their mortgages quickly without greatly increasing their monthly mortgage bills.
Alternative: Refinancing to a hybrid adjustable-rate mortgage (ARM), such as a 5/1 ARM, where the rate is fixed for five years and then adjustable for one-year periods, is appropriate for those who want the lowest possible interest rates for the next five years or so and who are confident that they will sell the home before the fixed introductory-rate period ends. Rates on 5/1 ARMs recently averaged 2.77%.
Those with ARMs. If you’re currently in an ARM and don’t plan to sell your house anytime soon, definitely consider refinancing to lock in today’s extremely low fixed rates. This may be prudent even if refinancing would result in a rate increase.
