Lower payments one reason to refinance

3/4/2012

HACKENSACK, N.J. -- As interest rates have slid over the last couple of years, Gabriel Bousbib of Englewood, N.J., refinanced his 15-year mortgage twice -- cutting his interest rate in two steps from about 4.6 percent to 3.375 percent.

He's one of a number of homeowners who refinanced just a year or two ago, but decided it was worth considering again as mortgage rates hit record lows -- now averaging around 4 percent for a 30-year loan.

"When you're quoting rates in the high 3s, people are saying, 'It's worth it to me,' " said Steve Hoogerhyde, executive vice president at Clifton Savings Bank.

"My monthly savings are going down a few hundred dollars; it adds up over 15 years," said Mr. Bousbib, a financial services executive. "And if rates keep going down, I would refinance again."

Refinance applications have more than doubled in the last year, though they're not as high as in previous refinancing booms because it's harder to qualify in this atmosphere of tighter credit standards, according to the Mortgage Bankers Association. With the volume of home purchases still low, refinancing accounts for about 80 percent of recent activity.

The guideline used to be that you should consider refinancing only when rates drop at least 2 percentage points. The new wisdom is that it can be worthwhile with smaller drops.

"For most people, if you can shave three-quarters of a percentage point off your interest rate, it's worth looking at," said Greg McBride, an analyst with Bankrate.com, a personal-finance Web site.

For homeowners who plan to stick with the same loan term and want to lower their monthly payments, the math is straightforward. Find out how much it will cost to refinance, figure out how much you'll save each month, and then how long it will take to break even. If you can save enough to offset the refinancing costs within a year or two -- or longer if you expect to stay in the house for a number of years -- it's worth considering.

Though low-interest rates are eye-poppingly low, the refinancing climate has changed from the easy-money days of five years ago. Generally, to get the best rates, homeowners need a 740 FICO credit score, well above the median score of 711. They also usually need at least 10 to 20 percent equity in the property. A recent expansion in the federal Home Affordable Refinance Program should allow refinancing this year by more so-called underwater borrowers -- those who owe more than their homes are worth.

Lenders are also demanding much more documentation -- pay stubs, tax returns, and bank statements -- than they did five years ago, at the insistence of government regulators as well as Fannie Mae and Freddie Mac, which buy mortgages from lenders.

"You have to have a taste for doing paperwork," said Keith Gumbinger of HSH Associates, a Pompton Plains, N.J., firm that tracks mortgage data. "You're going to be asked for lots of documents."

These stricter requirements are simply a return to the kind of underwriting standards that prevailed before lending standards slackened a few years back, leading to the housing bust and foreclosure crisis, Mr. McBride said. "We're in this mess because money was too easy to get."

Lowering the monthly payment is not the only reason people are refinancing. Many are shifting from a 30-year loan to shorter terms, said Matthew Gratalo of Real Estate Mortgage Network in River Edge, N.J. He has worked with clients in their 40s who hate the thought of carrying a mortgage into retirement.

Carl Nielsen of Mortgage Master Inc.for example, recently talked to a customer with a $375,000, 30-year mortgage at 4.5 percent. The customer is considering a 20-year mortgage at 3.75 percent.

The customer's monthly payments would go from $1,900 to about $2,223, but by shortening the life of the loan, he'll save more than $150,000 in interest payments.

And many homeowners are refinancing from an adjustable-rate mortgage to a fixed, so they don't have to worry that their monthly payments will rise, Mr. McBride said.

Time for a new mortgage?

• Check your credit reports at AnnualCreditReport.com and correct any errors.
• Comparison-shop among several lenders.
• Do the math. See how much refinancing costs, then check how much you'd save on monthly payments to figure how long it would take to break even.

For example: Let's say you have a 30-year, $300,000 mortgage at a 5.5 percent interest rate. Your monthly mortgage payments are $1,703.

If you refinance to a 4 percent rate, with monthly payments of $1,449, you'll save $254 a month. If your refinancing costs $3,000, you can break even in a year.

Or maybe your priority is paying off the mortgage faster. If you have a 30-year, $300,000 mortgage at 5.5 percent, you will pay more than $300,000 in interest over the life of the loan. Refinance into a 15-year loan at 3.5 percent, and your monthly payments will rise to $2,145. But you will pay only $86,000 in interest over the life of the loan.

Sources: Greg McBride, Bankrate.com