Refinancing Guide

With this refinancing guide you will learn the following:

• What exactly a refinance is and how it works
• The reasons why you should consider a refinance
• When you should refinance your mortgage
• How to streamline the refinancing process
• Tips for a problem-free refinance.

A mortgage refinance is when a borrower takes out a new home loan to be used to pay off an existing mortgage. In most cases, the new loan amount is less than the original loan because the principal has been paid down. In other cases, the new loan is bigger than the existing loan because the borrower wishes to cash out some of the equity that has accumulated in the home. In all cases, the amount of the new loan cannot exceed the lender’s loan-to-value (LTV) ratio requirement.

Depending on the borrower’s credit standing and the type of loan used in the refi, lenders will approve amounts of up to 80% of loan-to-value (LTV), although if your original mortgage is guaranteed by Freddie Mac or Fannie Mae, you could be eligible for a refinance of up to 105 percent.

The refinance process is nearly identical to taking out an original mortgage. You must be able to meet the lender’s requirements based on your credit standing and your income-to-debt ratio. Because the maximum loan amount is based on the value of the home (LTV), the appraisal plays an even more critical role. As with the original mortgage, a successful refinance depends on following clearly defined steps:

• Determine exactly how much you can afford to borrow based on your budget
• Get your credit checked.
• Gather your documents.
• Shop, compare and select a lender.
• Lock in your rate
• Get ready to close

Remember, at the beginning of a new loan the biggest portion of your payment goes towards interest. So, if you were to refinance your loan, say every five years, your payment is consumed by interest as opposed to principal. The net result is that your principal balance doesn’t decline as quickly.

You should only consider refinancing if it can substantially improve your long term financial picture. Here are the three primary reasons that most people choose to refinance:

Reduce your monthly payment. When interest rates drop, you can lower your monthly mortgage payment which can free up current cash flow. Some people may need to do this out of necessity in order to afford their mortgage payments. But if you are doing it to simply save cash each month, it is important to remember calculate the cost of homeownership over time. Any savings you derive today could be offset by additional interest costs in the long term. Unless you plan to stay in your home for at least another ten years, you may not make up the higher interest costs or the loan fees.

Reduce your loan term. With rates at their historic lows, it may make sense for some borrowers to opt for a loan with a shorter term that will enable them to lower their total costs and pay off their loan faster. Rates on 15-year mortgages are generally about a half point to three-quarters point lower than rates on 30-year mortgages, but, because of the shorter amortization period, your payment could still be higher. If a higher payment could create a cash flow problem, you may be better off applying extra principal payments to your existing 30-year loan which would give you more flexibility.

Cash out equity. Homeowners who have accumulated equity in their homes may want to tap into it in order to make improvements or utilize the equity for other purposes. A cash-out refinance enables you to borrow money against your equity in the form of a home equity loan or a home equity line of credit (HELOC). It’s important to consider the condition of the housing market in your area because, if home values decline, you could find yourself “underwater” if your equity falls below the debt on your home.

A lot has changed in the years following the mortgage meltdown. If you are among the fortunate home owners with positive equity and excellent credit, the right time could be now depending on some key considerations:

Refinancing a home loan should be about saving money now, or preventing increased costs in the future. While the possibility of lowering your payment should be a key consideration, the best time to refinance really depends on your individual financial circumstances and whether they will be significantly improved over the long term.

The key is that you must be holding a problem-free FHA or Veterans Administration (VA) loan. If you have had any issues with late payments, you may not be considered because the program is designed to reward homeowners who have demonstrated a solid payment track record. For those who qualify, they can benefit from an abbreviated loan process that could result in a lower interest rate or an extended maturity date, or both.

If your goal is simply to lower your monthly payment, the streamlined refinance won’t have to include a property appraisal. However, without an appraisal, there won’t be any cash-out equity available. Also, you won’t need income, asset or employment verification.

If you want to increase the loan amount to cash out some equity, then the process may require an appraisal. The maximum loan amount can be as high as 97.5 percent of the appraised value.
The best part about the FHA/VA streamlined refinance is that it may not cost you anything. Many lenders offer streamline refinancing at no or very low cost. The caveat is that they may charge a slightly higher interest rate. If you do end up incurring closing costs, most lenders will allow you to include them in your loan balance so you won’t have to come out-of-pocket.

So, if your monthly income is $5,000 your housing costs, including mortgage principal and interest, taxes, insurance and homeowners association dues, shouldn’t exceed $1,550. If you really want to play it safe, you could tack on an extra point or two to that cap and limit your costs to 29 or 30 percent.

You need to also consider your total debt picture, as most lenders do, to account for your total debt costs in relation to your income. The FHA requires that your total debt costs not exceed 43 percent of your monthly income. That includes any other mortgages, car loans, credit cards and also child support. Again, some lenders offering non-FHA loans may be more liberal with their limit, but, unless you are 100% that your income or debt situation will dramatically improve, you should assume a more conservative position with your lender.

Here are some additional key tips for ensuring a quick rate lock and a smooth closing:

Get organized. Before contacting a lender, gather your documents - income verification, bank statements, and tax returns – and make copies. Be sure to fill in any blanks, especially if you’re self-employed.

Don’t dawdle: As soon as the lender locks your rate, get your docs in that day. If you delay by a day getting your documents to your lender your application may get buried in the pile. And, have an appraisal done as soon after your application in paperwork are in.

Look out for the little guy: It’s never advisable to simply go with the first lender you talk with. If the big lenders tick their rates up to slow down the rush of applications, go across the street to the small lender who is willing to do more for you to get your business. Some are being very aggressive with their rates and closing timeframes.

Be a squeaky wheel: Don’t be annoying, but be on top of it. Stay involved. Expect the underwriters to ask for additional information or documents. It’s not uncommon for the loan officer to get tied down and delay getting to you with requests for information. Don’t wait for them to call you. Call them at least once per week.

Anticipate the next move: Don’t be afraid to pin your loan officer down with specific timeframes and milestones. Be especially adamant about the expected lock and closing dates. If there is any indication that their process is being slowed by volume, request a 45 day lock instead of a 30 day.