What does it cost to refinance? What are the benefits?

Ever heard the old rule of thumb, you should only refinance if your new interest rate is at least two points lower? That may have been true years ago, but with refinancing dropping in cost over the last few years, it's never the wrong time to think about a new loan! Refinancing has a number of benefits that often make it worth the up-front expenditure many times over.

When you refinance, you might be able to lower your interest rate and monthly payment -- sometimes significantly. You might also be able to "cash out" some of the built-up equity in your home, which you can use to consolidate debt, improve your home, take a vacation -- whatever! With lower rates and balances, you might also be able to build up home equity faster with a shorter-term new mortgage.

All these benefits do cost something, though. When you refinance, you're paying for most of the same things you paid for when you obtained your original mortgage. These might include settlement costs and other fees, an appraisal, lender's title insurance, underwriting fees, and so on.

You might have to pay a penalty if you refinance your previous mortgage too quickly. That depends on the terms of your existing mortgage. These penalties are illegal in some places, and more often than not when they're there apply only for the first year or two. We'll help you figure it out.

You might pay points to get a more favorable interest rate. If you pay (on average) three percent of the loan amount up front, your savings for the life of the new mortgage can be significant. You should be aware that the IRS has recently said that points paid for the purpose of refinancing your mortgage cannot be deducted in their entirety in the year you pay them, unless the refinanced loan is primarily for home improvements. Consult your tax professional before deducting points you pay on your new mortgage from your federal income taxes.

Speaking of taxes, if you lower your interest rate, naturally you will be lowering the amount of mortgage interest payments you can deduct from your federal income taxes. This is another cost that some borrowers consider. We can help you do the math!

Ultimately, for most people the amount of up-front costs to refinance are made up very quickly in monthly savings. We'll work with you to determine what program is best for you, considering your cash on hand, how likely you are to sell your home in the near future, and what effect refinancing might have on your taxes

Should you talk to a mortgage professional before house hunting?

Absolutely! Even if you haven't so much as picked out houses to visit yet, it's important to see your mortgage professional first. Why? What can we do for you if you haven't negotiated a price, and don't know yet how much you want to borrow?

When we pre-qualify you, we help you determine how much of a monthly mortgage payment you can afford, and how much we can loan you. We do this by considering your income and debts, your employment and residence situations, your available funds for downpayment and required reserves, and some other things. It's short and to the point, and we keep the paperwork to a minimum!

Once you qualify, we give you what's called a Pre-Qualification Letter (your real estate agent might call it a "pre-qual"), which says that we are working with you to find the best loan to meet your needs and that we're confident you'll qualify for a loan for a certain amount.

When you find a house that catches your eye, and you decide to make an offer, being pre-qualified for a mortgage will do a couple of things. First, it lets you know how much you can offer. Your real estate agent will help you decide on an appropriate offer, but being pre-qualified gives you the confidence to know you can follow through.

More importantly, to a home seller, your being pre-qualified is like you walked into their house with a suitcase full of cash to make the deal! They won't have to wonder if they're wasting their time because you'll never qualify for a mortgage to finance the amount you're offering for the home. You have the clout of a buyer ready to make the deal right now!

You can always use the calculators available on our site to get an idea of how much mortgage you can afford -- but it's important to meet with us. For one thing, you'll need a Pre-Qualification Letter! For another thing, we may be able to find a different mortgage program that fits your needs better.

What is a credit score?

Before deciding on what terms they will offer you a loan (which they base on their "risk"), lenders want to know two things about you: your ability to pay back the loan, and your willingness to pay back the loan. For the first, they look at your income-to-debt obligation ratio. For your willingness to pay back the loan, they consult your credit score.

The most widely used credit scores are FICO scores, which were developed by Fair Isaac & Company, Inc. (and they're named after their inventor!). Your FICO score is between 350 (high risk) and 850 (low risk).

Credit scores only consider the information contained in your credit profile. They do not consider your income, savings, down payment amount, or demographic factors like gender, race, nationality or marital status. In fact, the fact they don't consider demographic factors is why they were invented in the first place. "Profiling" was as dirty a word when FICO scores were invented as it is now. Credit scoring was developed as a way to consider only what was relevant to somebody's willingness to repay a loan.

Past delinquencies, derogatory payment behavior, current debt level, length of credit history, types of credit and number of inquiries are all considered in credit scores. Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or reestablishing a good track record of making payments on time will raise your score.

Different portions of your credit history are given different weights. Thirty-five percent of your FICO score is based on your specific payment history. Thirty percent is your current level of indebtedness. Fifteen percent each is the time your open credit has been in use (ten year old accounts are good, six month old ones aren't as good) and types of credit available to you (installment loans such as student loans, car loans, etc. versus revolving and debit accounts like credit cards). Finally, five percent is pursuit of new credit -- credit scores requested.

Your credit report must contain at least one account which has been open for six months or more, and at least one account that has been updated in the past six months for you to get a credit score. This ensures that there is enough information in your report to generate an accurate score. If you do not meet the minimum criteria for getting a score, you may need to establish a credit history prior to applying for a mortgage.

Five ways to make the loan process go faster

We should say that "working with us" is the first way! When you let us help you find the loan that's right for you, you truly are taking advantage of some of the area's best technology and expertise to get you a loan decision and funding on your loan quickly.

But here are five "other" ways you can speed up the process of getting a mortgage loan:

1. Have everything ready and in one place. Elsewhere on our website, you'll find a list of things you might need in support of your mortgage application. If you get them all together and keep them in a safe, portable place like a special pouch or folder, you can cut down on time spent rooting around for things we may need. Also, you'll help cut down on your own anxiety and confusion.
2. Be honest and complete when you fill out your application. "Fudging" your employment or residence history or omitting open credit accounts you'd rather not have considered doesn't increase your chances of getting a favorable loan. In 100 percent of cases, it makes it harder, and take longer.
3. Respond promptly to requests for additional information. During processing, we or the lender considering your loan may need additional information. Provide it as soon as you get the request, or return the call as soon as you get the message.
4. Be prepared to explain derogatory items in your credit report. This is really part of number 2 above. If you had an illness or a divorce where you missed or made late payments, or you have other instances of late payments or delinquencies on your credit report, be prepared to explain them. Be honest, and don't be nervous! The loan processor isn't judging you, they're trying to fill in all the blanks in their paperwork.
5. Let the appraiser in! The appraisal is one of the lengthiest parts of the mortgage loan process. Studies have shown that the single biggest factor in appraisal "lag time" is the appraiser's inability to reach the homeowner to make an appointment. If you're refinancing and the appraiser calls to make an appointment, make it as soon as convenient for both of you.

And remember that the appraiser doesn't want to buy your house. He or she will say what the house is worth clean and tidy and in reasonable repair, even if you have some dirty laundry on the laundry room floor or dirty dishes in the sink. Cleaning doesn't get you a higher appraisal! Letting the appraiser in as soon as possible gets you a loan faster, though.

What are the advantages of fixed rate versus adjustable rate loans?

With a fixed-rate loan, your monthly payment of principal and interest never change for the life of your loan. Your property taxes may go up (we almost said down, too!), and so might your homeowner's insurance premium part of your monthly payment, but generally with a fixed-rate loan your payment will be very stable.

Fixed-rate loans are available in all sorts of shapes and sizes: 30-year, 20-year, 15-year, even 10-year. Some fixed-rate mortgages are called "biweekly" mortgages and shorten the life of your loan. You pay every two weeks, a total of 26 payments a year -- which adds up to an "extra" monthly payment every year.

During the early amortization period of a fixed-rate loan, a large percentage of your monthly payment goes toward interest, and a much smaller part toward principal. That gradually reverses itself as the loan ages.

You might choose a fixed-rate loan if you want to lock in a low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can give you more monthly payment stability.

Adjustable Rate Mortgages -- ARMs , as we called them above -- come in even more varieties. Generally, ARMs determine what you must pay based on an outside index, perhaps the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others. They may adjust every six months or once a year.

Most programs have a "cap" that protects you from your monthly payment going up too much at once. There may be a cap on how much your interest rate can go up in one period -- say, no more than two percent per year, even if the underlying index goes up by more than two percent. You may have a "payment cap," that instead of capping the interest rate directly caps the amount your monthly payment can go up in one period. In addition, almost all ARM programs have a "lifetime cap" -- your interest rate can never exceed that cap amount, no matter what.

ARMs often have their lowest, most attractive rates at the beginning of the loan, and can guarantee that rate for anywhere from a month to ten years. You may hear people talking about or read about what are called "3/1 ARMs" or "5/1 ARMs" or the like. That means that the introductory rate is set for three or five years, and then adjusts according to an index every year thereafter for the life of the loan. Loans like this are often best for people who anticipate moving -- and therefore selling the house to be mortgaged -- within three or five years, depending on how long the lower rate will be in effect.

You might choose an ARM to take advantage of a lower introductory rate and count on either moving, refinancing again or simply absorbing the higher rate after the introductory rate goes up. With ARMs, you do risk your rate going up, but you also take advantage when rates go down by pocketing more money each month that would otherwise have gone toward your mortgage payment.

"I am about to shop the mortgage market. Can you give me a handy list of the mistakes I need to avoid?"

Here are some of the worst.

• Select The Loan Provider Offering The Best Price Over The Telephone Or In The Newspaper
  
  If you cast a wide net, you are bound to find a rogue who will beat all the other prices, but has neither the capacity nor the intention of delivering such prices. His objective is to rope you in and move the process along until it is too late for you to back out. At that point, he raises the price using any of a dozen tricks available for that purpose.
• Remember: Because the market is constantly changing, you can’t hold a broker or lender to a price quote until you lock the prices. A lock is the lender’s agreement guaranteeing the prices
  
  Assume That You Can Shop Lender A Today And Lender B Tomorrow
• Because of market volatility, prices obtained on different days are not comparable. Unless you shop all sources on the same day, you are wasting your time.
  
  Solicit Price Information Without Providing All The Information About Your Loan That May Affect The Price
• Prices vary with numerous borrower, property and transaction characteristics that lenders believe affect their risk and cost. These include loan size, credit rating, type of house, your ability to document income and assets, etc.
  
  Unless informed to the contrary, lenders quoting prices assume a set of standard specifications that generates the lowest price. If the specs on your loan differ at all, the price will be higher.
• For example, lenders assume you are purchasing a single-family house as your permanent residence. If in fact you are buying a condo, or the house is intended as a second home, expect to pay more.
  
  Accept a Mortgage Broker’s Verbal Assurance That You Have Been Locked With The Lender
• Some brokers tell the borrower the price has been locked, but don’t lock with the lender. If interests rates don’t rise between the supposed lock date and the closing date, the broker makes an extra profit. If interest rates spike during that period, which is unlikely but always possible, you’re left holding the bag.
  
  Don’t be afraid to ask for written confirmation of the rate lock.
• Allow The Price To Float Without An Agreement With The Loan Provider Regarding How The Price Will Be Determined At Closing
  
  Some borrowers elect to allow the price to "float" -- change with the market -- until shortly before closing. Such borrowers are told they will receive the "market price" at the time they lock. Few loan providers, however, explain how the market price is determined.
• The market price at closing should be the price available if the loan were delivered immediately. This is also the price quoted to new customers electing to float on the day you lock. Because the lock price is always higher than the float price, floating should save you money if interest rates don’t rise.
  
  The reality, however, is that in the absence of an agreement to the contrary, the market price at closing is what the loan provider says it is. And many say that it is the 30 or 45-day lock price, rather than the float price.
• Assume That The Loan Provider Who Offers The Best Price On One Type Of Loan Will Also Have The Best Price On Another
  
  It is common for borrowers to shop the loan they think they want, then change their mind later in the process. For example:
  
  *They begin thinking they want a fixed-rate loan, then switch to an adjustable.
  
  *They begin thinking they want a 30-year term, then switch to 15-years.
  
  *They begin thinking they want a zero-point loan, then switch to 3 points.
  
  Such switches may invalidate their shopping because the loan provider with the best price in one loan category may not have the best price in another.
  
  One way to avoid this mistake is to retain an Upfront Mortgage Broker (UMB) to shop for you.
  
  Copyright Jack Guttentag 2002