Consider your goals when deciding to refinance

Jerri Stroud

The rules have changed in the refinancing game.

With the real estate market sluggish and credit tight, replacing your mortgage could be harder than buying a house was a few years ago.

Kathy DePung, senior mortgage lender at Midwest Bank Centre in Oakville, said, "The guidelines have all changed. Everything is being verified again."

Lenders want proof of your income, employment and assets like bank accounts and investments. And they're more likely to quiz you about why you want to refinance and whether it makes sense to do so.

Many bankers say you shouldn't refinance unless you can save enough to recoup the costs of the new loan within a year or two. The equation is driven more by monthly savings than by the difference in interest rates. The savings on a very large loan can be significant with a small drop in rates.

Bankers should be able to provide a good-faith estimate of costs up front.

"I like to see them recover their costs in a year," DePung said. "Then it's really worth it."

DePung said people who want to pay their loan off faster often would be better off making an extra principal payment than refinancing, especially if there's a small difference in 30-year and 15-year rates. Payments on the shorter-term loan would be higher, and you'd also have the closing costs.

Credit score requirements for conventional loans have been raised, driving up interest rates for borrowers with scores lower than 680, DePung said. Private mortgage insurance isn't available to borrowers with scores below 620, which means they can't get loans with high loan-to-value ratios.

Before applying for a loan, it's a good idea to check your credit report with one of the three major credit reporting agencies: Equifax, Experian or TransUnion. You are entitled to a free report from each agency once a year, and you can pay a few dollars more to get your credit score. Check the report for errors, and ask the agency to correct them.

Be wary of offers for free credit scores. Many require you to sign up for credit monitoring. The monitoring service can add more than $10 a month to your credit card bill after an introductory period, and it can be tricky to cancel.

Free credit reports can be obtained at annualcreditreport.com or by calling 1-877-322-8228.

Some lenders advise against applying for new credit cards or a car loan when you're also applying for a house loan. Credit scores sometimes fall if you have too many lenders checking your credit.

Borrowers with low credit scores probably should consider getting a loan insured by the Federal Housing Administration, said Mark Barron, a vice president at Pulaski Bank. Credit scores aren't as much of an issue with FHA loans, and borrowers can get loans for up to 97 percent of a house's value.

Dan Wetzel, vice president of Fifth Third Bank, said, "We need to have a very extensive conversation with a homeowner about value. We recognize that if the value comes in low, we could be in the position of not being able to do the loan at all. Or if we could, it could come with an increase in rate or cost."

DePung advises homeowners to check with real estate agents to find out about recent sales of comparable houses in their neighborhoods before they seek refinancing. Some borrowers make the mistake of using their tax assessment value, which is usually lower than an actual appraisal.

Wetzel said borrowers can get a rough idea of the value of their house at Zillow.com, Realty Trac or Blockshopper.com. Zillow, for example, estimates the value of your house and lists sales of comparable houses in your neighborhood.

Barron said house values are coming in near his estimates for the most part, but some borrowers who have owned their houses for less than two years may be disappointed that they haven't appreciated.

DePung said one of the big factors in refinancing is how long a borrower plans to stay put. Anyone who plans to move in a year or two probably should keep the loan they have if they can afford it.

Borrowers who plan to move within five years may be better off with an adjustable-rate loan than a fixed rate, but they need to make sure they're comfortable with how the loan rates reset, Barron said.

Important factors are the index used to set the rate and the margin above that charged by the lender. The lender should be able to explain it so you understand it. Be wary of margins above 2.75 percent.

Barron said fixed and adjustable rates were fairly close until recently. They have diverged significantly since the Federal Reserve cut rates sharply earlier this year.

John Frank, president of Paramount Mortgage, said he's seen wide swings in rates over the course of a day, so locking in an attractive rate may make sense.

Financial planners generally frown on refinancing to consolidate credit card debt, but it could make sense if house values are rising and you expect to move in a couple of years.

However, Barron said borrowers in this situation should stop using their cards or they'll find themselves in the same pickle before long.