June 2012

JUNE 2012: What You Need To Know About - Refinancing

Author: Lew Wessel | Photographer: Photography by Anne

Seems like every other piece of junk mail I get is a hyped up offer to refinance my current mortgage. “Refinance Now!” “Rates are at an historic low!” “Don’t miss out on this once and a lifetime opportunity!” As one who firmly believes that if something sounds too good to be true, it is, I normally advise against getting too excited about these come-ons. In this case, however, the hype is reality. Four percent on a 30-year fixed mortgage is, in fact, a truly amazing rate—just 1 percent above historic inflation rates. If you haven’t explored this opportunity, I encourage you to do so. What I will warn you about—what is not too good to be true—is that the refinancing process involves significantly more than a flip of the switch from your current to a lower rate. The process can be downright grueling! Nevertheless, the end result will, in most cases, be worth the effort. Here is what you need to know.

Before we get too far into the subject we need to make a distinction between loan refinancing and a loan modification. A modification is a restructuring of your current loan, which may involve reduction in principal, interest rates, terms, etc. Loan modification begins with a call to your current loan servicer (the people to whom you send your monthly mortgage payment). If you are in trouble on your loan, have missed a payment or two or more, this is going to be your primary and possibly only route to some sort of debt relief.

Refinancing, on the other hand, is a process in which your current loan is completely paid off and simultaneously replaced with an entirely new loan. The new loan may or may not be originated, owned and/or ultimately serviced by the same companies as your old loan. Unlike a modification, if you have been delinquent on your current mortgage, you’re not going to qualify for refinancing, even through one of the more flexible government programs such as FHA, VA or HARP (see below). Why not? Remember, this is a new loan, and why would anyone want to give you a new loan if you have failed to meet your obligations on your old loan? Refinancing will also be precluded if your credit rating is below 620 or your financial ratios (see below) are not even close to acceptable levels.

The primary reason to refinance, expressed quite simply by Brian Neumann of Mortgage Network, is that mortgage interest rates are, indeed, at an all-time low—around four percent. Even if your current rate is five percent, which, at least historically isn’t bad at all, refinancing to four percent has the potential to save you thousands of dollars per year in interest. Another factor to consider is the terms of your current loan(s). If your current mortgage has a variable interest rate or has a balloon payment coming due in the next few years, refinancing into a 30-year fixed mortgage may be a great idea. It will certainly reduce the stress in your financial future.

Assuming you qualify to refinance, the end result must make bottom-line financial sense. There are lots of formulas and rules-of-thumb you can use to determine this, but, to put it as simply as possible, if you can at least recoup the cost of refinancing through future savings on mortgage payments, then refinancing makes financial sense. As Nick Kristoff, also of Mortgage Network, points out, this calculation is going to be different for everyone, because it depends on the interest rate spread between the old and new mortgage, the amount of time you expect to hold the new mortgage, and other factors.

Thanks to the new Dodd-Frank Consumer Protection Act and other consumer protection laws, your loan originator will give you a complete and binding list of all the expenses involved in refinancing your mortgage. These will include such items as a new appraisal of your property (the collateral for your loan), fees for the attorney doing the closing and numerous other charges including, perhaps, a loan origination fee. In some cases, these fees may be included in your new mortgage by increasing your loan amount; in others, the fees may be paid by increasing your loan rate. Assessing the bottom line can get complicated, but, in general, it will involve simply multiplying the interest rate difference between the old and new mortgages by your principal balance and then multiplying the resulting number by the number of years you expect to spend in your home. If the resulting number is more than the cost of refinancing, you’ve got a winner…maybe.

Even if refinancing makes financial sense, is it really worth it to you? Using a seasoned mortgage banker or broker can help, but I can tell you from my own recent personal experience, refinancing is not for the faint of heart. While everyone’s financial situation is unique, be prepared to provide your most recent tax returns, every K-1, brokerage statement, W-2, etc. that went into those returns and significantly more financial minutia if you happen to be self-employed and/or own rental properties. Expect the whole process to take anywhere from 45 to 100 days or more, depending on the mortgage professional you use. (Do your research on this!) Only you can decide if the end result is worth the effort.

Note: The refinancing process for FHA and VA loans is a super streamlined process, according to Kristoff. If you are lucky enough to have one of these loans, contact a mortgage pro and get moving on a lower rate!

It helps to picture the qualification process as a three-legged stool. No matter how strong those legs are, the stool collapses if one of the legs fails. You have to pass all three of the following tests in order to qualify:

Income ratios: Your total debt payments, which basically include every recurring monthly payment, including mortgages, auto loans, credit card bills, etc., cannot exceed 45 percent of your gross income. In calculating this ratio, the underwriter is going to use historical and verifiable information, which usually means your prior tax returns and supporting information such as K-1’s and brokerage statements. If you have been less than forthright on your self-employment (Schedule C or 1120S) income, this is, unfortunately for you, payback time.

Credit scores: Although you may be able to refinance with a credit score in the 600s, you are going to need a score of 740 or more to qualify for the best rates. One note of caution here: The score you see on various websites may not be the true FICO score used by the mortgage industry. Your mortgage professional will fill you in on the details.

Loan-to-value ratio: This must be no higher than 80 percent (i.e. a 20 percent down payment) to qualify for the best rate. Anything less will require mortgage insurance, an additional monthly fee that will be added to your mortgage payment until you reach the magic 20 percent equity figure. (Note: this fee will vary based on your credit score, loan amount and loan to value ratio.) Remember when the loan-to-value ratio used to be the only ratio mortgage lenders cared about? Now it’s the least important of the three although, as mentioned, you still must hit all three numbers to qualify for the best rate.

Note: Refinancing is certainly possible with less equity; in fact, under the Home Affordable Refinance Program (HARP), even seriously underwater mortgages are eligible for refinancing if owned by Freddie Mac or Fannie Mae. Unlike loan modifications, you won’t be able to qualify for this program if you have missed a mortgage payment within the last six months.

The gatekeepers of the mortgage origination process include mortgage bankers, mortgage brokers and banks. Banks and mortgage bankers (which are sometimes subsidiaries of banks) originate, underwrite and purchase loans; in other words, they control the entire process. They will more than likely sell your loan after closing, but up until then, it’s entirely their show. Mortgage brokers, as the name implies, guide you through the process, but other entities actually make the decisions on your loan.

You’re going to have to choose one of these three to handle the process. Even though Fannie Mae or Freddie Mac will probably end up owning your loan, you can’t pick up the phone and deal directly with either of them. So which should you choose? Someone you know and trust and, in my opinion, someone local who understands the local real estate and general business market. Don’t hesitate to get a second opinion if the first mortgage professional you contact is negative about your situation. The refinancing profession is more art than science, and a hard-working, smart mortgage professional can work financial magic for you (Magic…not miracles).

Under the Dodd-Frank duty of care provision, mortgage originators, including brokers and bankers, are now licensed and regulated and must pass an initial competency exam as well as complete continuing education requirements. You can verify a mortgage professional’s license through the National Mortgage Licensing Systems website.

I hate to show my age, but my first mortgage, in 1979, carried a whopping 10 percent interest rate. I purchased my second home a few years later with a 15 percent first mortgage and a 13 percent owner-financed second mortgage. I felt lucky at the time to get both of them. So, today’s four percent rate on a 30-year fixed mortgage does, indeed, strike me as an amazing opportunity. I encourage you to sit down with a mortgage professional whom you trust to discuss the possibilities.

To comment or for more information, e-mail lewwessel@hargray.com.

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