Don't wait: Now's time to refinance

By Liz Pulliam Weston

A poster on the Your Money message board was thinking about refinancing his mortgage after his credit union offered an interest rate under 5%. But then his wife brought up the possibility that if they waited, rates might go even lower.

"She says that there is talk that the feds are going to help plain old folks like me (who haven't gone delinquent or done anything else wrong) refi at 4.5%," wrote the poster, "TheBeardedAxe," who wanted to know: "Is there any truth to this? If the feds are going to steer the ship, it might save me interest and closing costs. If they aren't going to intervene, I should start the process myself."

He isn't alone. I've been fielding similar inquiries from readers dying to take advantage of some of the lowest mortgage rates in recent memory but wondering whether committing now could mean missing out on even better deals later.

• Watch the videos to the right for more home financing advice.

Such "interest-rate regret" is always a concern when you sign up for a mortgage, because rates change all the time. But today we've got the added factor of a newly interventionist government, which has already driven rates down considerably and whose next move is unclear.

Here's what you need to know:

• The Federal Reserve has been driving the bus. In normal times (remember those?), mortgage rates are determined by a complex interplay of market forces, including investor appetite for risk. As that appetite dried up last year, mortgage rates on plain-vanilla, 30-year fixed-rate conforming home loans rose from around 6% at the beginning of the year to more than 7%. Finally, the Fed stepped in, announcing it would buy loans from mortgage giants Fannie Mae and Freddie Mac -- essentially filling in for AWOL investors. The result: Average mortgage rates plunged to the lowest levels since reliable tracking began in the early 1970s.

• No plans have been announced to allow refinances for less. The Wall Street Journal in December reported that departing Treasury Secretary Henry Paulson was considering a plan to drive down mortgage rates for new homebuyers (not refinancers) to 4.5%, a report Paulson later denied. Plenty of other folks have suggested the government intervene further than it already has, either by increasing the mortgage purchases to drive rates lower or by setting up other programs that would allow homeowners in good standing to refinance for less. So far, though, these ideas are just talk.

• No one knows what the Fed will do next. The lower rates have already set off a refinancing boom, bringing great cheer to mortgage lenders who were despairing just weeks ago. At this point, the Fed doesn't seem poised to intervene further, said Paul Havemann, a vice president at HSH Associates, which tracks mortgage trends.

"The Fed stepped in and got the credit spigots running," said Havemann, who doesn't expect average rates to drop much below 5%.

About those low, low rates

Let's pause for a moment to discuss rates.

"Average rates" are just that, the average of what lenders are offering across a region or country. You can track the daily averages here and the wholesale rates offered to lenders here. "Street rates" (rates from individual lenders) may be lower than the national average, or they may be higher. Mortgage brokers who have multiple funding sources and can adjust their profits on each loan have more flexibility than big banks.

• Talk back: Do you want to refinance soon?

Street rates change all the time, as lenders lower theirs to win more business or, alternately, raise rates to slow down a torrent of applications. You typically won't see a street rate below the wholesale rate unless there are extra fees involved. If you see an eye-popping advertised rate -- say, 4.2% on a day when the wholesale rate is 4.6% -- then the lender is typically demanding that you pay extra fees, called points, to get that loan.

(Each point is 1% of the loan amount, and a rate far below the average may cost 2 points or even more. It usually doesn't make sense to pay points to get a refinance unless you plan to be in the house a decade or more, because it generally takes that long to recoup the extra costs.)

Lastly, remember that even if the loan terms are the same, origination fees and closing costs can vary by hundreds of dollars. Those differences are accounted for when you compare the annual percentage rates rather than base rates.

Back to your regularly scheduled refinancing

Another mortgage expert, Dick Lepre of Residential Pacific Mortgage in San Francisco, isn't so sure the Fed is done tinkering. Lepre, who writes a mortgage newsletter, still sees a lot of volatility in interest rates that he says indicates the mortgage market remains far from normal. But even if the Fed steps in again, Lepre said a 4.5% rate with no points would be the "absolute rock-bottom" rate the Fed would likely shoot for -- and the possibility is slim enough that he wouldn't advise waiting for it.

Erik Bacon, a broker at All American Home Lending in Eagle, Wis., says his office is hopping, with many refinancers ready to roll but waiting and watching before pulling the trigger. Would he wait? "If you can get a loan that begins with a 4," he advises, "jump on it."

Lepre agrees, suggesting his clients get their paperwork together, submit their applications and lock in when they can get a no-points rate between 4.75% and 5%.

"Don't think you can guess the bottom. You can't," Lepre said. "I can't, and I pay a lot of attention to this."

Continued: There's a catch

The savings could be considerable even if you don't catch the exact bottom. Let's say you got your last loan during the 2003 refinance boom and locked in a rate of 5.375% on a 30-year, fixed-rate loan for $350,000, setting up a monthly payment of $1,959.

Now, more than five years later, you've paid down the balance to $321,000. If you refinance into another 30-year loan and lock in a 4.81% rate, your payment plummets to $1,686, a monthly savings of about $273.

You knew there was a catch, right?

To get the best deal on a refinance, here's what you'll need:

• A FICO credit score above 740. At that threshold, lenders see a break on wholesale rates that they can pass along to borrowers. You can still get a loan with a lower score, but you will pay more.

• A big loan, but not too big. A bigger loan allows a lender to cut his markup but make the same amount of money. But if it's "jumbo" -- $417,000 for most places, $625,500 in a few high-cost areas -- Fannie Mae and Freddie Mac won't buy the loan from your bank, making it riskier and therefore pricier. Current rates on jumbos are about 2 percentage points higher.

• Equity. If your mortgage balance equals 70% or less of your home's current value, you're usually in luck. Those with a loan-to-value ratio of 70% or less typically get a break on their rates. In areas hard-hit by foreclosures, though, some lenders may limit your loan to 60% of current market value. And be prepared for "appraisal shock." Falling home values, especially in foreclosure-prone areas, mean your home may be worth less than you think. Consider using a valuation tool such as MSN Real Estate's or a site like Zillow.com. You might talk to a local real-estate agent about what your home is worth now, so you don't pin your hopes on a loan that you can't get.

• No big cash-out. You can still get a new loan that's bigger than your old one and use the extra cash to pay off other debt, remodel your home or whatever. But you can't borrow as much as you used to be able to. Lenders pay more if loan-to-value rises above 70%, so you will, too. Some lenders charge more if your loan-to-value on a cash-out refinance exceeds 40%.

• Documented income. Haul out those W-2s, because lenders are unlikely to approve a loan without them. The self-employed –- particularly those who write off most of their incomes -- will face tremendous hurdles until the credit market thaws.

Bacon advises those with scores below 680 and those who want to cash out a substantial amount of equity to consider a Federal Housing Administration loan. Because mortgage insurance is built into the cost of the loan, mortgages backed by the FHA can accept more risk. Loan-to-value can be as great as 95%, and borrowers qualify based on recent financial history rather than on their credit scores.

But wait, there's more

Before you submit any application for a refinance, though, you should have a plan for managing your mortgage and any savings you get. Consider:

• Not every homeowner should refinance. Read "4 reasons not to refinance" to make sure swapping loans makes sense for you. It might not, for example, if you're many years into your current loan or if you're likely to move soon, since you may not recoup the costs of refinancing. If you're being charged $2,500 to refinance, your payments will drop by only $100 and you plan to move in two years, for example, you won't see much, if any, real savings.

• Thirty-year loans aren't for everyone. Refinancing typically means restarting the clock on your mortgage. That's fine for many homeowners -- read "Don't rush to pay off that mortgage" for the reasons -- but it may not be a good idea if you're closing in on retirement (do you really want to owe money on your house when you're 80?) or if you're determined to be debt-free. You may want to consider a 20- or 15-year mortgage instead.

• Savings matter only if you put them to good use. If you're refinancing to lower your payments, make sure you don't fritter away the extra cash. Use the freed-up money to boost your retirement contribution, pay off your credit card bills, save for your kids' college educations or build up your emergency fund. That way, you'll be ahead of the game rather than just further in debt.

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of a Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

Published Jan. 19, 2009