Refinancing a mortgage today is a lot like navigating a minefield. One wrong step and your refinance gets blown to pieces. We just closed on a new loan for our primary residence and are in the process of refinancing a loan on an investment property.
The recent experience with mortgage brokers and banks reminded me of the many issues that can derail a refi. So if you are considering or are in the process of refinancing, here are some tips to keep in mind.
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Safeguard your credit score: Your credit score is as important with a refinance as it was with your original loan. The credit score required to refinance a mortgage will vary from program to program. As a rule of thumb, however, a score in the high 700s is necessary to qualify for the lowest rates. As your score dips into the low to mid 600s, qualifying can be difficult. The key is to know your credit score and protect it until you’ve closed on the loan.
Avoid new credit: One way to protect your credit score is to avoid applying for new credit. Whether it is a new credit card, a car loan, or a line of credit, it’s best to hold off on new credit until the refinance closes. Simply applying for new credit can lower your score. It is equally important to pay your current debt on time. Paying a loan even 30 days late can lower your score by more than 100 points.
Be realistic about home values: The single biggest hurdle to refinancing today is home values. A few years ago a ridiculously low appraisal scuttled our first attempt at refinancing our home. It was only after paying off more than $100,000 in a home equity line of credit that we were able to refinance our mortgage earlier this year. While there are no silver bullets, you can appeal the appraisal if you believe it to be in error. If your curious, here are several free websites to check out the value of your home.
Know that loan modifications are a pipe dream: While the government has hyped loan modification programs, the reality is less sanguine. Qualifying for a loan modification is almost like winning the lottery. Just recently Bank of America was named in a class action lawsuit over a loan modification gone wrong. While homeowners should explore every opportunity to lower their mortgage payments, with loan modifications, make sure you know what you are getting into.
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Avoid cash out refinancing: A cash out refinance is one in which the new loan is more that the existing mortgage balance and closing costs. Homeowners obtain cash out refinancing for many reasons, such as making home improvements and paying off high interest debt. The first problem with a cash out, however, is that interest rates are higher. Second, the loan-to-value ratios typically go up when a cash-out refinance is involved. Under Freddie Mac’s guidelines, for example, the LTV with no cash out can go as high as 95 percent, but only 80 percent if you take cash out. That’s not to say that cash-out is never a good choice. But recognize that it comes with significant downside.
Don’t chase rates: It may be tempting to hold of locking in your rate to see if you can shave an eighth or even a quartern off the rate. The problem with this strategy, however, is that it’s pure gambling. Interest rates can just as easily go up a notch as they can go down. And current refinance mortgage rates are already at historic lows. If you can get a rate that makes refinancing a good deal, why take chances? As they say, one in the hand is worth two in the bush.