Cover story: To refinance or not? Variables are many

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In addition to comparing mortgage loan rates, homeowners should compare their options for paying closing costs. Lenders sometimes are able to offer a “no-cost” refinance, in which the lender pays all costs. A no-cost refinance typically has a slightly higher interest rate than a mortgage with closing costs. Borrowers who choose to pay closing costs can pay them upfront or wrap the costs into the loan if they have sufficient equity in the home.

“If you plan to stay in your home for five years or less, you may be better off doing a no-closing-cost loan,” Mr. Lieb says. “If you plan to stay longer, you will be better off in the long run paying those costs because you will be paying a lower interest rate for the entire loan period.”

In addition to discussing loan options with a lender, borrowers can use a mortgage refinancing calculator, such as the one available from Bankrate.com (www.bank rate.com/calculators/mortgages/refinance-calculator.aspx). This calculator evaluates the difference in mortgage payments from one loan to the next and compares this difference to the cost of refinancing to find out how long it will take to recoup your expenses.

While plenty of homeowners would like to take advantage of refinancing into today’s low mortgage rates, not everyone will qualify. The two biggest obstacles to refinancing are home values and credit scores. As home values have dropped, some homeowners who once had 20 percent or more equity in their home are discovering they have low - or even no - equity in their property. Equity is the difference between the current home value and the amount due on the existing mortgage and all other liens, such as a home equity line of credit.

“The good news is that many homeowners can refinance even if they have low equity because of government programs in place for loans owned by Freddie Mac and Fannie Mae,” Mr. Cohen says.

Mr. Lieb recommends that homeowners with low equity check with their lender to see if they qualify for a refinance. He says some lenders will refinance up to 120 percent or 125 percent of the home’s current value.

Borrowers with low equity who do not qualify for a special government program will have to pay private mortgage insurance (PMI) if their equity is less than 20 percent, even if they have not been paying PMI with their current loan.

“A lender can calculate the difference in payments with different scenarios, but for many people it would still make sense for them to refinance even if they have to start paying PMI,” Mr. Cohen says. “For example, if you are going from a 6.5 [percent] interest rate to a 4.5 [percent] interest rate, even with adding PMI you are likely to have lower monthly payments. Also, for most people, PMI payments are now tax deductible.”

Another option for homeowners with cash available is to pay down the principal on their existing loan to qualify for a new loan without paying PMI. Some borrowers are opting to pay down their loan balance to qualify for a new loan regardless of whether they would need to pay PMI.

Homeowners who have not applied for a new loan in several years may not be aware that lenders have stricter guidelines for borrowers in terms of their credit score and their debt-to-income ratio, regardless of whether they have been paying their mortgage on time.

“Lenders are credit-sensitive now, and so only borrowers with a credit score of 740 and above will qualify for the lowest mortgage rates,” Mr. Cohen says. “Consumers with scores from 700 to 740 may pay a slightly higher interest rate of about one-eighth to one-fourth of a percent higher.

“If you contact a lender, you can find out your credit score and get an assessment of what you might need to do to improve your credit score, if necessary. But probably, even if you have to pay a slightly higher rate, you will still be better off than what you are paying now on your mortgage.”

Mr. Lieb says the bare minimum credit score to qualify for most loans now is 620, but, he says, consumers should understand that a variety of factors goes into the credit decision.

“Even someone with a credit score of 680 might not qualify, depending on the reason for their score, such as having too many credit lines open or using too much credit compared with the credit limit,” Mr. Lieb says. “If they are having a dispute with a creditor that shows up on their credit report, that could cause the underwriter to deny the loan, at least until the dispute is cleared up.”

Lenders must follow guidelines for debt-to-income ratios now, as well, so some borrowers may not qualify if their monthly minimum debt payments require more than 40 percent to 45 percent of their gross monthly income.

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