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.

Homeowners with less than 20% equity may still be able to refinance, Gumbinger says, but they'll probably need to buy private mortgage insurance. Private mortgage insurance, which protects lenders against default, is no longer available in some markets where home prices have plummeted because insurers no longer want to take the risk, Gumbinger says. And even if you can get mortgage insurance, the monthly premiums will reduce the savings from refinancing.

Sadly, the millions of Americans who owe more on their mortgages than their homes are worth — known as being "underwater"— won't be able to refinance. Those borrowers "really don't have a lot of alternatives," Findlay says.

An unencumbered first mortgage.

If you have a home equity loan or line of credit, you'll probably need to pay it off before refinancing, says Bob Walters, chief economist for Quicken Loans.

Before a lender will refinance your first mortgage, it typically needs approval from the lender that holds your second mortgage. The lender with the second must agree to "subordinate" the loan, which means it will take second place behind the new first mortgage.

In the past, that hasn't been a problem. But in the wake of the credit crunch, many lenders are eager to rid themselves of home equity lines and loans, which are considered riskier than first mortgages. As a result, Walters says, many lenders are refusing to subordinate their loans.

A conforming loan.

Borrowers in high-cost areas may not qualify for the lowest rates, even if they have outstanding credit, lots of equity and no second mortgage. That's because the interest rates for loans that exceed $625,000 — known as jumbo loans — have remained high. The average jumbo rate is 6.8%, according to Bankrate.com.

Nationwide, the lowest rates are limited to loans of $417,000 or less. Those are known as "conforming" loans because government-sponsored mortgage giants Fannie Mae and Freddie Mac will buy them in the secondary market. That makes those loans less risky for lenders. In some instances, Freddie and Fannie also will purchase loans for up to $625,000. The rates on these loans, which Gumbinger calls "expanded conforming" loans, averaged 5.28% last week, according to HSH.

Trouble is, expanded conforming loans are only available in some parts of the country — mainly New York, Los Angeles, San Francisco and Washington, D.C., Gumbinger says. In Boston, where there are plenty of high-cost homes, the expanded category only covers loans up to $465,750. Loans above that amount are jumbos, with jumbo rates.

Patience.

Flint-Budde, the financial planner in Salem, N.Y., recently called her mortgage broker to talk about the mortgage on investment property she owns. Her call wasn't returned for two days. Some borrowers are waiting much longer to get their calls returned, if they can get through at all.

Banks and other financial institutions laid off thousands of workers last year, leaving many unprepared for a sharp rise in mortgage applications. That has led to a logjam in processing applications. Some borrowers are having a hard time getting their lenders on the phone.

In this market, Gumbinger says, "Patience is not just a virtue, it's a necessity."

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