Should You Refinance? Here’s How to Tell If It Makes Sense

There’s a lot more to refinancing than plugging loan terms into a mortgage calculator to figure out how much you could reduce your monthly payments.

For starters, refinancing costs a lot. You can expect to pay most, if not all, of the closing costs you would pay for a purchase loan. That includes fees charged by the bank and mortgage broker as well as fees for an appraisal, title insurance, and credit report, among others. The total could easily reach several thousand of dollars.

Even if you’re reducing your monthly payment by several hundreds of dollars, it may be a year or more before you offset the money you’ll have to bring to the table when the loan closes. You need to make sure the payoff occurs relatively quickly.

So it’s important to consider how long you expect to live in your home. If you’re planning to sell in the next couple of years, refinancing, even with low refinance rates, may not be worth the trouble. (You may be able to “roll” the closing costs into the new mortgage, but you’ll be paying interest on the additional money you borrow for years to come.)

Some  mortgages, particularly those made to riskier borrowers, come with penalties for paying them off early, although there are fewer and fewer of these. So-called subprime loans typically penalized borrowers for selling or refinancing in the first two or three years of the loan, and most lenders stopped making these loans in late 2006 or early 2007. So most of these subprime loans are already more than two or three years old – and no longer subject to the prepayment penalties.

Do You Qualify?

Another pitfall to refinancing: you may not qualify. As this article is written in July 2009, banks are stuck with a lot of bad loans on their books, and they’ve become much pickier about who they will lend to and on what terms. You may not qualify for the best rates anymore.

These days you need a credit score of at least 740 to qualify for the best mortgage rates -  those on loans backed by Fannie Mae or Freddie Mac. Brian Brady, a principal at World Wide Credit Corp., a mortgage broker based in San Diego, said you qualify for a loan backed by one of these companies with a score as low 620, but the pricing is “tiered,” with the interest rate banks can offer falling, at intervals of 20 points or so, for better scores.

“It’s risk-based, so the better your credit, the lower the rate will be,” he said.

You also need to have some equity in your home, which isn’t a given these days. Home prices have fallen so far and transactions are so few that it can be difficult to come up with an accurate valuation, or at least one that’s acceptable to your lender.

If listings in your local market are dominated by foreclosed properties, this could negatively affect the appraisal of your property, even if it is in pristine condition. As a rule, you can’t refinance a loan that’s for more than 80% of the value of your house.

However, there are new government programs for borrowers who have little or no equity in their homes. Borrowers whose loans are up to 97% of the value of their homes may qualify to refinance with a mortgage insured by the Federal Housing Administration.

And the Making Home Affordable program allows borrowers with conforming loans owned by Fannie Mae or Freddie Mac to refinance if their current mortgage is as much as 125% of the current value of their home.

But if you want to refinance a loan bigger than $417,000, you may be out of luck. So-called “jumbo loans,” those too big to qualify for purchase by Fannie Mae or Freddie Mac, are pretty hard to find these days, although the limits on the size of loans Fannie and Freddie has been raised to as high as $729,750 in some high-cost markets like New York and San Francisco.

– This article was written in July 2009