Low mortgage rates make refinancing attractive

— -- The past few months have been lonely ones for mortgage lenders, but business is picking up. The phones are ringing, and banks don't have to give away doughnuts to attract customers. They've got something much more enticing to offer: rock-bottom mortgage rates.

Last week, the average rate for a fixed-rate 30-year mortgage was 5.68%, down sharply from 6.34% a year ago, according to Freddie Mac fre. The drop in rates has prompted a surge of refinancing as homeowners look to get out of adjustable-rate mortgages or lower the rate on their fixed-rate mortgages. Applications for mortgage refinancing rose 22% for the week ended Jan. 25 from the week earlier, the Mortgage Bankers Association says.

Should you jump on the refi bandwagon? Unless you're already paying a low fixed rate, it's certainly worth considering, especially if you plan to stay in your home at least several more years.

Some borrowers may be tempted to hold out in hopes that rates will fall even more. But that's risky, says Bob Walters, chief economist for Quicken Loans. Long-term mortgage rates are near historic lows, he notes, which means they're more likely to rise than fall. The Federal Reserve reduced short-term rates by half a point last week and signaled that it might cut rates even more in the next few months. But while Fed cuts typically lead to lower rates for credit cards and car loans, the Fed doesn't influence long-term mortgage rates. These rates track 10-year Treasury notes, which tend to respond to changes in the economy.

In fact, "There are times when short-term rates go down and mortgage rates go up," says Jim Svinth, chief economist for LendingTree.com, a website that connects borrowers with lenders.

Long-term rates are particularly sensitive to any whiff of inflation, which causes bond yields to rise. If Congress approves an economic-stimulus package, Walters says, mortgage rates could move higher on fears that the stimulus will boost the inflation rate.

The bad news

Though mortgage lenders are hungry for business, credit standards have tightened. That means some borrowers won't qualify for the lowest rates, and some won't be eligible to refinance at all. To take advantage of low rates, you'll need:

•A good credit score. To get the lowest mortgage rates, you'll need a FICO score — named after the model developed by Fair Isaac fic— of at least 680, and preferably above 700, Svinth says.

•Equity. Some lenders are offering competitive rates for borrowers who have as little as 5% equity in their homes, as long as their credit scores are above 680, Walters says. Some borrowers with at least 5% equity and lower credit scores will also be able to refinance, he says, but they'll pay more.

If, however, you're one of the millions of homeowners who are "upside down"— you owe more on your mortgage than your home is worth — you won't be able to refinance, Walters says.

•A conforming loan. The decline in mortgage rates has been limited to so-called conforming loans. These are loans that can be bought by Fannie Mae fnm and Freddie Mac and resold to investors. Only loans of $417,000 or less are considered conforming loans.

Rates for mortgages that exceed that limit, known as jumbo loans, haven't declined along with rates for conforming loans. Last week, the average rate for a 30-year fixed-rate jumbo loan was 7.03%, according to Bankrate.com.

No free loan

Here's a scary sign of the times: Last week, mortgage refinancing promotions accounted for 10% of all spam, according to Commtouch ctch, which develops anti-spam products. Whenever interest in a product or service rises, shady operators tend to emerge.

For that reason, it's important to make sure you're dealing with a reputable lender and to scrutinize all offers. To stand out from the crowd, some lenders are promoting "no-cost" refinancing. But those deals are "rarely free," Svinth says. Some no-cost loans carry a higher interest rate, he says. In other cases, the costs are rolled into the loan, which means you would end up financing them for the next 30 years.

"As a consumer, you need to have your eyes wide open," Svinth says. "If somebody is offering you something for free, they're earning it back someplace else."

Paying upfront fees can help you negotiate a lower rate than you'll get on a no-cost refinancing. But before you sign any papers, think about how long you plan to stay in your home. If, for example, you pay $2,500 in closing costs to lower your monthly mortgage payment by $100 a month, you'll need to stay in your house for 25 months before you start saving money. You can find a refinancing calculator at www.bankrate.com.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.