The lowest mortgage rates in our lifetimes are inspiring a huge volume of new mortgages. The Mortgage Banker's Association, a national organization representing the real estate finance industry -- expects to see nearly $3 trillion in business this year. But it's not only new buyers that are tempted to apply for home loans. Nearly 80% of recent loans went to current homeowners refinancing.
The association says that the average buyer of a 30-year fixed mortgage with 20% down now pays 4.63%.Last year the average rate was 5.98%.
But, many people are finding out that they don't qualify for those great rates they've been hearing about. If you're interested in refinancing, you'll have to carefully figure out whether it will work for you right now. Here are some tips to help you navigate the field of refinancing.
Clean up your credit first
You are going to have to have great credit to get the best rates. That may mean a score of at least 740. That could be hard if you're motivated to refinance because your budget is too tight.
Start by getting a copy of your credit record and credit score. If your credit score is not high enough, consider working on it for a few months by paying down debt, removing errors and applying again -- especially if you are within 100 points or so of 740. After all, of all the factors banks consider when you apply for a loan, this is the one you can change the most easily.
Expect to wait longer & try harder
Instead of the usual 30 days it used to take to refinance, count on a four to six week process, says John Holmgren, spokesman for the California Association of Mortgage Brokers. Banks are scrutinizing loan applications a lot more than they did in the recent past.
"As a general rule a lot of people who have gotten loans in the past will find there are a lot of changes and challenges," he said.
Consider the same payment over a shorter mortgage
If you can swing your current payment, instead of just refinancing to get your monthly bill down, consider changing to a 15-year mortgage. Depending on your situation, you may be able to do it with little or no increase in your monthly payment. But you'll get out of debt much sooner, so your overall interest payments will be much lower. And in case you sell your house in the interim, you'll have built up much more equity.
Don't overextend yourself
Lenders are getting back to the traditional way of thinking about debt to income ratios. And so should you.
Just a few decades ago, lenders didn't want you to pay more than one-quarter of your monthly income to your debts. In industry jargon, that's a debt-to-income ratio of 25%. So for example, if you wanted to take out a mortgage with a payment of $1,000 a month, lenders expect that you would make to make at least $4,000 a month.
The 25% ratio was what was called a front-end debt to income ratio -- just your house. Banks may also look at your back-end debt ratio, which includes all the other monthly loan payments you make, such as credit cards, car or student loan payments.
The problem comes in when some lenders began allowing the debt-income ratio to creep up to 30%, then 35%, with back-end ratios going over 50%. Including a home loan, that means some people would end up spending more than half their salary solely on loan payments. That's not a position you want to be in, so set a debt-income ration for yourself, and stick to it.
Pay the points, especially if you plan on staying for the long run
Back when you got your mortgage you probably chose not to pay points (a 1% fee on your principal you pay upfront to lower your interest rate) or closing costs. Now, to get the best rates, you're going to have to -- but it's probably worth it.
"When people see statistics, they assume that it's a loan with no points," says Holmgren, but changes in the way loans are priced means there is often a big difference in the average rate and what you get.
"Most people are electing to pay a point or more because it makes a huge difference," he says.
Paying higher costs up front will reduce your monthly payment more, but it also means you have to stay in the house longer to make the refinancing worthwhile.
Don't be shocked by what the bank says your home is worth
This is the part that may break your heart: if your home fell in value by more than you added in equity, you may not even have enough for what amounts to the 20% down payment on your mortgage.
When you refinance, it's like you're buying your house all over again. The bank is only going to loan you what they think your house is worth now; what you paid for it doesn't matter. You may have a magical number stuck in your head; the highest price someone paid for a home in your neighborhood, the price you wish you had sold at, the price you think your house is inherently worth.
The bank doesn't use those price markers, but instead, looks at comparable sales, lots of them. Traditionally banks wanted to see three comparable properties recent sale prices, Holmgren says. Now they want to see more and possibly what current sellers are asking to detect further downward trends.
"A lot more property value data is being required," he says. Every home owner seems to tell themselves that their home is nicer than their neighbors, so that they ignore those current prices, he says. "If I had a penny for every time people say houses are selling for this, but mine is so much better ..."
You'll pay more for condos and investment properties
You always had to pay a little bit higher of a rate for an investment property, Holmgren says, but not that much -- maybe one-quarter or one-half a percent. Now you may be looking at a whole percentage point higher. The best rates you see are for single-family homes that you live in.
For condos, lenders worry that buying just part of a building is more risky than buying a single family home. There are too many other risk factors you can't control, and they have higher default rates.
Fannie Mae recently tightened restrictions on condo loans: they won't guarantee loans in mostly still-vacant buildings or ones where 15% or more of owners are behind on their mortgage. They're also charging an added fee unless you have a 25% down payment.