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Lack of Equity Can Derail Mortgage Refinancing

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By Kara McGuire

(MCT)—With mortgage interest rates hovering around 50-year lows, refinancing is an appealing prospect for many homeowners. I think this is especially true considering the stock market’s August gyrations. Taking nervous energy and using it to focus on sure-thing money moves such as lowering payments or paying debt faster makes sense.

According to Freddie Mac’s weekly rate survey, a 30-year, fixed-rate mortgage averaged 4.22 percent. Slice the term in half, and the rate is 3.39 percent for a 15-year, fixed-rate mortgage.

Problem is, refinancing isn’t always possible for homeowners.

The key culprit? Home equity. Homeowners across the country are saddled with low equity—or negative equity—in their homes. While refinancing is possible with as little as 3 percent or 5 percent home equity, it may be less worthwhile after taking mortgage insurance and closing costs into account, says Alex Stenback, a mortgage banker with Residential Mortgage Group in Minnetonka, Minn.

If you don’t have home equity, you still may qualify using a government refinancing program called HARP. Greg McBride, senior financial analyst at Bankrate.com, says HARP is “the Rodney Dangerfield of government housing programs … all the attention goes to the loan modification program, which hasn’t solved any problems.” But HARP (for Home Affordable Refinance Program) can be tough to qualify for, especially for borrowers with second mortgages and mortgage insurance. Plus many homeowners who qualify have already taken advantage of this program.

Lenders also want to see consistent, steady income. “If they’ve had challenges with employment in the past two years, gaps in their employment, that would be the second-biggest challenge,” says Kara Egan, vice president of a realty mortgage company in Edina, Minnesota. “You’d typically need to be back on the job for six months,” she says. Recent retirees or families relying on self-employment or contract income could also find it difficult to qualify.

Another hurdle for many burned by the recession is having a high enough credit score. The magic number to receive the very best rates is at least 740. You can still qualify for a loan with a score south of 740, but forget about getting a brag-worthy interest rate. But with today’s low rates, “most people have good enough credit to get the lowest rate they’ve ever seen,” McBride said.

Here’s a little-known tip for the credit-challenged but cash-flush. Surprisingly, for 15-year, fixed-rate mortgages, lenders don’t adjust the rate up or down based on credit score. “If you’re willing to step up and make the higher payment, they’re willing to overlook credit blemishes, to a degree,” says Dan Hughes, loan officer in Plymouth, Minnesota. Generally, you still need a credit score in the mid-600s to qualify for a loan, but if you do, your rate will be as good as your neighbor scoring north of 800.

Refinancing through FHA is also an option for those with scores in the 600s, but a recently increased upfront mortgage insurance payment makes it less attractive.

So you are the poster child of financial health. Does it always make sense to refinance? For Wanda Kath, who has had the same mortgage at 6.65 percent that her family used to buy its “forever” home in Buffalo, Minn., 18 years ago, looking into a refinance is a no-brainer. Even if the she took the no-closing cost route, accepting a slightly higher interest rate for paying nothing at closing, she’d end up with a rate far lower than what she currently has. If she wanted, she could shorten the term of her loan to a 10-year mortgage. Or she could take the monthly payment savings and plow the money into her loan in order to pay off the loan on the existing 30-year timetable.

For rate-chasers who may have refinanced several times, the answer isn’t quite as simple. Hughes tells clients that refinancing makes sense if they can pay no closing costs and still reduce their rate. But it’s a hassle, and before you start the process, consider that the difference in monthly payment may only buy you a couple of pizzas. For example, the monthly principal and interest payment for a $170,000, 30-year, fixed-rate mortgage at 4 percent is $811. Jack up the rate to 4.25 percent and you’d save only $25 a month. Is it worth the hassle of the appraisal and paperwork to save that little?

Probably not.

5 Ways to Get A Lower Rate:

1. Research your home’s value. Looking at your home’s tax value, checking online estimates, or asking a real estate agent for a price opinion can help you determine how much your home might be worth. But those methods will be off 5 to 10 percent almost every time, experts say. “Off 5 to 10 percent is the difference between refinancing the house and not refinancing the house,” says mortgage banker Alex Stenback. The only way to know for sure if a refinance is in the cards is to order up a $400 appraisal.

2. Check your FICO credit score. It’s the most widely used score in the mortgage industry. If you are concerned about your credit, buy your FICO score from one of two credit bureaus for $19.95 ($39.95 for both) at myfico.com. You can also estimate your score at the site, or at www.creditkarma.com.

3. Call your current mortgage holder to see if they can offer a better deal without an appraisal and major paperwork. Compare any offer with at least one bank and credit union before ordering an appraisal. It may also pay to work with a mortgage banker who has access to multiple lenders.

4. Consider the term. Many families are switching from 30-year mortgages to shorter terms. Some are even throwing cash into the mortgage at the closing table. Considering a recent Bankrate.com survey that showed only 24 percent of Americans have at least six months of emergency savings, paying the mortgage faster may not be the best choice for many. My family refinanced to a 15-year mortgage in 2010. It’s working out so far, and I’m happy we’ll have the house paid off before our younger kids are college-bound. But I really like Stenback’s idea of starting a housing fund in a savings account that could be used for a down payment when it’s time to move, a remodel or just a cash cushion.

5. Create a plan for the money freed up by a lower monthly payment. Will you take the savings and throw that money back into the mortgage to reduce principal faster? Will you start saving for college or retirement or finally pay off that credit card debt? Come up with a plan. Otherwise, you risk whittling that money away with nothing to show for it.

©2011 the Star Tribune (Minneapolis)

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