How to Refinance a Mortgage

Most people finance their homes assuming that the housing market and the value of their homes will continue to climb at breakneck speeds. What happens if the housing market declines and the appraised value of your home starts dropping?

If the housing bubble in the US bursts just like the Internet bubble did, many overextended homeowners will find themselves in financial hot water and risk losing their homes. Here is what you can do to protect yourself in case of the inevitable market downturn.

Buy Within Your Budget

Because mortgage interest rates have been so low, many homeowners purchased larger homes than they could afford using interest only mortgage loans. The problem with overextending yourself becomes painfully evident when the market takes a downturn, interest rates rise, and your mortgage payment becomes unmanageable.

Monitor Your Loan-to-Value Ratio

If you use a home equity line of credit, always keep your loan-to-value ratio below 80%. If you keep your LTV below this level you provide yourself a healthy cushion if the appraised value of your home falls. If the value of your home falls below that of your outstanding mortgage balance you will no longer have enough equity in your home to secure the mortgage.

If you use home equity loans for any reason, borrow conservatively. If you stretch yourself too thin and fall behind on the home equity payments you could lose your home. A down economy is not a good time to borrow against home equity; the risks involved greatly outweigh any benefit your could receive from that money.

Avoid Cash Out Refinancing

In a down economy cash-out refinancing can be just as risky as a home equity loan. The less equity you own in your home the more an economic downturn will affect you. This is why adjustable rate mortgages, especially option and interest only mortgages, are so risky. If your tolerance for financial risk is low, you should refinance using a traditional, 15 or 30 year mortgage with a fixed interest rate. A mortgage with a 15 year term would allow you to build equity at a much faster rate; the more equity you have in your home the better off you will be in the inevitable economic downturn.

To learn more about building equity in your home and avoiding common homeowner mistakes, register for our free mortgage guidebook: “Five Things You Need to Know before Refinancing Your Mortgage.”

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If you are refinancing your current mortgage but are concerned about how you will prove your income to the mortgage lender, a no doc or low doc mortgage could be right for you. There are a number of reasons for refinancing a mortgage; these reasons include getting a lower interest rate, dropping private mortgage insurance, cashing out equity, or lowering your monthly payment. When you qualify for a new mortgage the lender will require documentation of your income, employment, and assets.

No doc loans allow you to qualify for a new mortgage without providing this documentation. There are reasons why some homeowners are unable to document their income. People who work on a commission basis or are self-employed often find it difficult to document income for sustained periods of time. Other homeowners are very particular about their privacy and would rather pay a higher interest rate than disclose to the world their private financial information.

In order to qualify for a no doc mortgage loan you must have excellent credit. Mortgage lenders are not going to take your word that you can afford the mortgage payments unless you have a sterling credit rating. The interest rates for refinancing with a no doc loan are higher than a traditional mortgage because of the increased risk to the mortgage lender. A low doc mortgage differs from a no doc loan in that you are providing the lender with some documentation in the form of your stated income and employment history. Low doc mortgages come with lower interest rates than no doc loans because there is less risk for the mortgage lender.

No doc loans are ideal for the homeowners that want to protect their privacy. Low doc mortgages are good for the self employed that can state their income and show employment history to back up their stated income. Because no doc and low doc mortgages come with higher interest rates than traditional mortgage loans, refinancing your current mortgage with a no doc or low doc mortgage will probably not get you a better interest rate; however, you may be able to secure more favorable terms or cash out equity in your home. You will need to research no doc mortgage lenders and carefully compare loan offers to find the best deal for your new mortgage loan. To learn more about refinancing your mortgage and how to avoid common mortgage mistakes, register for our free mortgage guidebook: “Five Things You Need to Know Before Refinancing Your Mortgage.”

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Balloon mortgages are often referred to as “reset mortgages,” these loans lure homeowners with very low interest rates and 5 to 7 years to repay. These mortgages carry a significant amount of risk for the borrower. Here is what you need to know to minimize the risks with these mortgages.

Repayment of this mortgage is based on a 30 year repayment schedule; however, the borrower only makes payments for five to seven years. This allows the borrower to make low payments for the duration of the loan. At the end of the loan period the balloon payment for the remaining balance is due; some lenders allow you to refinance at the end of this period for a fee.

Balloon mortgages allow the borrower to qualify for a much larger loan amount than they could with a traditional mortgage; when abused these mortgages have the potential to ruin the finances of the unsuspecting homeowner.

Balloon mortgages are designated by the lender using a numbering system. The loan can be represented a 7/23 loan. This means the borrower has seven years before the balloon payment becomes due; the balloon payment represents 23 years of principal. If you add these two numbers together you will get the amortization schedule, which is thirty years.

The lender may allow you to automatically reset the mortgage when the balloon payment is due. The lender may require that you have made all of your mortgage payments on time to qualify for the reset. If you do not qualify for the reset with your current mortgage lender you can still refinance through another mortgage lender.

Balloon mortgages do not come with caps to prevent large changes in the interest rate or monthly payment amount. This makes them significantly more risky than a standard Adjustable Rate Mortgage. If you are unable to pay off the balloon payment when it is due and cannot qualify to refinance the mortgage the lender will foreclose and take your home. To learn more about finding the best mortgage while avoiding common mortgage mistakes, register for our free mortgage guidebook.

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When you close on your new mortgage you may be able to save on your out of pocket expenses by closing late in the month. You will be required to pay the interest due from the day you close until the end of the month; the closer to the last day of the month you can close on the mortgage, the less you will have to pay out of pocket.

Mortgage payments are typically made for the previous month. After you close on your mortgage your first mortgage payment will be due two months later; for instance if you close in May your first payment is due in July. This mortgage payment covers the interest due for the month of June. Interest on the mortgage starts accruing the day you close. This unpaid interest will be due at closing; if you close on the last day of the month you will only be charged one day of interest.

Here is an example of the potential savings.

If you borrow a $150,000 at 6.5% interest the daily amount you will pay in interest is calculated by multiplying the loan amount by the interest rate and diving by 364 days. For this example, the daily interest rate is ($150,000 x .065) = $9750/364 = $26.78 interest per day.

If you were to close on the 15th of May you would be required to pay 15 days worth of interest which amounts to $401.70. By closing on the 30th of May you would be required to pay interest for two days in the amount of $53.56.

The amount of your savings depends on your mortgage closing dates. If you are unable to close at the end of the month and your closing date spills over to the first week of the next month, your closing costs will increase dramatically. To learn more about saving money on your mortgage register for our free mortgage guidebook: “Five Things You Need to Know Before Refinancing Your Mortgage.”

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If you are refinancing your mortgage your credit score will largely influence the interest rate and terms you receive for your new loan. Understanding your credit is the first step in qualifying for a better mortgage. Here is what you need to know about your credit score.

The FICO credit score that many mortgage lenders use to gauge your credit worthiness is generated by a company called Fair Isaac Corporation. This company evaluates the contents of your credit file and based on a proprietary scoring method, generates your credit score. FICO credit scores range from 350 to 850. The higher your FICO score the better; having a high credit score will allow you to qualify for better loan offers.

Your credit score tells mortgage lenders at a glance, how much of a risk you are. If your credit score is too low many lenders will deny your mortgage application. If your credit score is poor, but not too low, you may still qualify for a mortgage; however, the lender will charge you a higher interest rate and fees for the loan.

Mortgages lenders break credit scores down into varying degrees of good and bad. Lenders generally consider having a FICO score of 720 to 850 to be excellent credit. A credit score of 675 to 720 is a fair to good credit rating. If your credit score is 620 to 675, mortgage lenders consider you to have average credit. Below 620 you will start paying more for your mortgage. If your credit score is between 500 and 560, mortgage lenders start considering you a high risk borrower.

There are steps you can take to improve your credit score before applying for a mortgage loan. The first step is to make all of your monthly payments on time; thirty five percent of your credit score is based on your history of late payments. It is important to have a minimum of six months worth of on-time repayment history in your credit history before applying for a mortgage. Other steps you can take to improve your credit score include paying down the balances on your credit cards and closing accounts you do not need. To learn more about qualifying for a better loan when refinancing your mortgage, register for our free mortgage guidebook: “Five Things You Need to Know before Refinancing Your Mortgage.”

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