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Refinance your mortgage (again)?

Consumer Reports Magazine: January 2012

Illustration: David Senior

Some 58 percent of homeowners who have mortgages—that’s about 28 million households—pay interest rates that are higher than today’s bargain rates. Many could save thousands by refinancing. Are you one of them?

Trading in a higher-rate mortgage for a cheaper one has become almost ritual in the past two decades. Some homeowners refinanced several times as interest rates on 30-year fixed mortgages went from around 10 percent in the early 1990s to about 4 percent in early November, when rates were at their lowest levels in 50 years.

Long-term savings
That has created yet another opportunity to cut your monthly mortgage payments or accelerate your home’s payoff by refinancing into a shorter-term loan, which can slash your total interest costs.

How much can you gain from refinancing? If you took out a 30-year, $200,000, 6.7 percent mortgage five years ago, your monthly payment is almost $1,300. Refinance the $188,000 balance with a 25-year, 4 percent mortgage, and your payment would drop by $300 per month, saving you $90,000 in finance charges over 25 years.

Rates on 15-year mortgages are even lower, averaging 3.4 percent in early November. Shortening the loan term often results in a higher monthly payment. If you refinanced the above five-year-old loan to a 15-year, 3.3 percent mortgage, your monthly payment would go up by about $30. But by paying off your loan 10 years sooner, you’d save $149,000 in interest.

You’ll get the biggest savings from refinancing early in your loan term, but if you can slash your rate, you can still save even if you have less than 10 years left on your mortgage. For example, if you have six years left on a 15-year, 5.6 percent mortgage written in 2002 and you refinanced to a 15-year, 3.6 percent mortgage, you’d cut your monthly payment by $922. You’d also extend your mortgage by six years, which would increase your total interest costs by $11,600. But if you paid an additional $850 each month toward your principal, you’d pay off the new loan in six years and save about $6,800 in interest.

To crunch the numbers on your own specifics, try the calculator at www.hsh.com/refinance-calculator. The calculator accounts for closing costs, about 2 percent of the principal, and can be paid out of pocket or folded into the loan amount.

Do you qualify?
The best candidates for refinancing have regular income, at least 10 to 20 percent equity in their homes, and a FICO credit score of 740 or better. But borrowers with scores as low as 620 can qualify for a Federal Housing Administration mortgage, which are available through banks, credit unions, and other lenders. People who don’t meet those criteria might have to jump over hurdles.

Low equity. If you’re underwater, owing more than your home is worth, you might get help from the federal Home Affordable Refinance Program. When it was introduced in early 2009, HARP allowed refinancing for up to 125 percent of value for mortgages owned or guaranteed by Fannie Mae or Freddie Mac. “The program was badly designed,” says Keith Gumbinger, vice president of HSH Associates, a rate-comparison service, “because it asked lenders to take on additional risk for no reward—a lower interest rate.” In October, the Federal Housing Finance Agency announced that HARP would be revamped to reduce fees and remove the 125 percent loan-to-value limit that kept severely underwater homeowners from refinancing. The changes could prompt 2 million new refinances in the coming year, according to CoreLogic, an information and analytics firm.

If you have a home equity line of credit or second mortgage on the property and can pull together the cash, try to pay that off, advises Chris Goode, mortgage product manager at Informa Research, a financial-market-research company. That will increase your equity by reducing the amount of debt against the property.

Reduced income. If your income has dropped since you got your mortgage, you might not be able to get a straight refinance. If you can afford about three--quarters of your payment, you might qualify for a loan modification. “Some lenders just change the rate lower,” Goode says.

Unemployment. You probably won’t be able to refinance without a regular income. But you might be eligible for relief through forbearance—the lender lets you suspend or make partial payments for up to 12 months while you search for a job. You might also be eligible for a reduction in principal through the Hardest Hit Fund, a federal foreclosure-prevention program in markets where home prices have collapsed the most. Check with your lender or go to www.makinghomeaffordable.gov.

   

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