With interest rates for home loans at historic lows, many Americans are wondering whether they should refinance their mortgages. The appeal is obvious: Lock in a lower rate, reduce your mortgage payment and free up some of your monthly cash flow to meet other expenses. Unfortunately, in a real estate market that's as crazy as this one is, refinancing can be anything but simple. The following tips can help you decide how to proceed.
1 Know the new rule of thumb. For years the prevailing wisdom was that you should consider refinancing if you could lower your rate by two percentage points and stay in your home at least two years — but that has changed a bit. "People might want to do it if they're lowering their rate by 1.5 points and if they can stay in the house at least 2.5 years," said Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. "It's not going to get any better than it is now, so ask yourself: Can I pay myself back within 30 months for all of my closing costs?"
2 Realize that the upfront costs can be brutal — even if your monthly payments go down. When you refinance, be prepared to encounter many of the same costs you paid when you got your original mortgage, including settlement costs, discount points, escrow fees, an appraisal report and other expenses. This can add up to thousands of dollars and more than offset your monthly savings.
3 How long have you been in your house? In a mortgage's early years, you're mostly paying the interest on your loan while barely touching the principal. Refinancing your mortgage typically involves paying off your original mortgage, signing a new loan and resetting the clock back to zero. This may not be advisable if you've lived in your house a long time and you've reached the point where you're paying principal much more heavily.
4 Are you under water on your mortgage? If you owe more money than your home is worth, you likely won't be able to refinance all on your own. President Barack Obama's new housing plan may be of help to you, though. The plan is designed to assist people who are just a little bit under water and whose loans are held by Freddie Mac or Fannie Mae to refinance.
5 Consider having your loan modified. Homeowners who are in more dire straits may qualify for a "loan modification" under Obama's housing plan to make their mortgage payments more affordable. For more details on Obama's plan, visit www. financialstability.gov/makinghome affordable/. (Note: This help is available for free, so don't give money to a "mortgage rescue specialist" or "mortgage modification specialist." Also, beware of www. financialstability.org, a site that has popped up selling various services. Type carefully!)
6 Are you the ideal candidate for a refinance? People with pristine credit — typically meaning a credit score above 740 — and with enough equity in their homes should qualify for one of the fabulously low rates being advertised. If you could possibly handle letting your monthly payments go up slightly, consider locking in a low rate and switching from a 30-year fixed loan to a 20-year or even a 15-year loan. Reducing the length of your loan could save you tens of thousands of dollars in interest.
7 Do some calculating. Online calculators can help you see whether refinancing makes sense for your situation. Decent calculators are offered by Bankrate.com (www.bankrate.com/brm/calc_vml/refi/refi.asp) and HSH.com (www.hsh.com/usnrcalc.html).
8 Be careful about using a refinance to pay off credit card debt. "Cash-out" refinances are popular because they leave people with extra cash in their pocket to pay off other bills, including credit card bills. That may sound wise at first — but watch out. "It's not the best idea to be paying off credit cards with a 30-year loan," Cunningham said. "I also think it's bad because people had been struggling to make their credit card payment, and now they're going to be struggling to make their new housing payment."
9 Check your credit reports and your credit score yourself. Order free annual credit reports from all three of the major credit bureaus by going to AnnualCreditReport.com or calling toll-free 1-877-322-8228, and purchase a copy of your credit score from myFICO.com (www.myfico.com). If you skip these steps, the lenders sitting across the desk from you will know more about you than you do.
10 Be wary about sharing information online. Online lending sites promising "fast" refinancing and "instant" approvals abound — and many of them will instruct you to type in your Social Security number with haste. Considering the magnitude of this transaction, it makes more sense to keep your personal information to yourself until you're sure you're dealing with a reputable lender. As you shop around for one, ask each lender to provide you with a comprehensive list of fees you'll be expected to pay at closing. If you're quoted a fantastic rate in combination with reasonable fees, consider locking in the rate that day.
Laura T. Coffey can be reached at email@example.com.
Sources: Gail Cunningham of the National Foundation for Credit Counseling (www.nfcc.org); John Schoen, "Answer Desk" columnist for msnbc.com (answerdesk.msnbc.com); Michael Zoretich, loan originator manager for CK Mortgage in Oregon; FinancialStability.gov (www.financialstability.gov/makinghomeaffordable/)