Not Everyone Can Refinance

Jan. 18, 2009— -- The average interest rate for a 30-year mortgage dipped below 5% this week, a level not seen since the Eisenhower administration. Not surprisingly, homeowners are scrambling to commemorate this historic event by refinancing their mortgages.

There's just one problem: In this credit-starved environment, even a five-star general might have trouble qualifying for a new mortgage. If you're interested in refinancing, here's what you'll need:

Excellent credit.

To get the lowest rates, you'll need a FICO credit score of 720 or higher, says Cameron Findlay, chief economist for LendingTree, a loan-comparison website.

To avoid surprises, you should obtain your credit score before you apply for a mortgage, says Nancy Flint-Budde, a financial planner in Salem, N.Y. Your credit score is based on information in the credit reports compiled by the three main credit bureaus: TransUnion, Equifax and Experian. You can order a free copy of all three of your credit reports once a year at www.annualcreditreport.com. You'll have to pay extra for your credit score.

Once you've received your credit reports, check them for errors that could hurt your score. If your reports show late payments — and the information is accurate — the only way to repair the damage is by showing lenders that you've changed your ways, says Craig Watts, spokesman for Fair Isaac, developer of the FICO score. That will take time, because you need to demonstrate a pattern of on-time payments.

However, if your credit reports show large credit card balances, you can raise your score quickly by paying them off, Watts says. Your "credit utilization" ratio, which reflects to the amount you've borrowed as a percentage of your available credit, accounts for 30% of your credit score.

Home equity.

Ideally, you should have at least 20% equity, based on your home's current appraised value, says Keith Gumbinger, vice president of HSH Associates, a publisher of mortgage and consumer loan information. Most lenders will require an appraisal before refinancing your loan, and if the value of your home has dropped, you may be unable to refinance, or decide it's not worth the trouble.