Liz Pulliam Weston

The Basics

Time to refinance is now

Even if your loan isn't going to reset in the near future, there are good reasons not to wait. Sinking home values eat into your equity, making it harder to get a new loan.

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By Liz Pulliam Weston

Rates on 2 million mortgages are scheduled to rise by the end of 2008. If yours is one of them, consider refinancing now -- if you can.

Falling home values are eroding people's equity rapidly enough that some who can refinance today might not be able to do so in a year, notes mortgage expert Dick Lepre. Even those who have plenty of equity now may face more limited options and higher costs in a few months.

That's because much of the refinance math lenders do depends on how much equity you have in your home:

  • If your mortgage and other home loans equal 80% or less of your home's worth, you'll typically have the most choices and be offered the best rates, contingent on your credit scores.

  • As your equity shrinks, though, rates tend to get higher and terms get stricter, said Lepre, a California loan officer who writes a weekly newsletter on the mortgage business. Every time you slip over an equity benchmark -- 85%, 90% and 95% -- rates tick up and your options decrease.

  • Once you owe more on your house than it's worth, your alternatives pretty much decline to none, at least in today's mortgage market. Lenders who were once eager to make 100% or more loan-to-value mortgages have either gone out of business or turned away from these high-risk loans.

Risk is in waiting, not acting

What a difference a few months makes. In the recent past, the only folks who had to worry about not having enough equity to refinance were those who had already gobbled it up with home-equity borrowing. Even that was a temporary situation, as ever-rising home values continued to supply more equity.

Now that home prices are dropping in many areas, the easy equity gains have turned into equity erosion. Someone with a $200,000 mortgage would have an 80% loan-to-value on a home worth $250,000, but if that home drops 10% in value, to $225,000, the same loan now represents 89% of the home's worth.

Another glitch: Appraisers are getting more conservative, in response to pressure from lenders. If an appraiser decides your home is worth $220,000 instead of $225,000, you've risen above the 90% loan-to-value mark and will find your refinancing options further reduced.

Lepre worries that many folks who should be refinancing are sitting on the sidelines, hoping for lower rates. That might be a gamble worth taking if real-estate values are still strong in your area and the supply of unsold homes isn't building. If prices have already tumbled or there's more than a six-month supply of homes on the market, though, he'd opt for refinancing now.

Continued: Downturn might last for years

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