The bursting of the housing bubble in 2008 has redefined the American real estate landscape in just about every aspect. Nowhere is this more evident than in a tightened credit atmosphere which makes getting a mortgage or refinancing as difficult today as it's ever been. Where banks used to have 35 to 40 rate sheets to work from 20 years ago, many are down to one or two today. So if you're thinking about refinancing your home, be prepared to do a little bit of work.
Fortunately, the process of refinancing has not changed. You contact area banks and home lenders to find out what they can offer based on your circumstances. You shop around a bit, find the one that best suits you, and submit your application. The lender then goes through the process of verifying your information, approving your loan, doing due diligence in terms of appraisal and inspection, and then writing a check. You close on the refinanced mortgage the same way as you did the first time, and you're done. However, while the process hasn't changed some of the nuances have.
Home Value
One of the biggest problems facing refinancing today is the significant drop in real estate prices. Many experts in the industry agree that 2011 prices are more in line with reality than the inflated prices of the 80s and 90s. For many home buyers looking to refinance, what the experts think is irrelevant. The fact is you have a home that's worth only a certain amount on the open market, period. Any bank willing to refinance your mortgage must look at that value in order to assess his risk. And no lender worth his salt will write a loan greater than the market value of the property.
Unfortunately, many homeowners find themselves underwater as a result of the housing collapse. Being "underwater" means that you owe more on your home loan than what the house is valued at. For instance, you may have purchased a house in 2001 at a price of $250,000 only to see property values drop to the point where your house is only worth $175,000 today. Yet in the short 10 years you've owned your home you've only reduced the principle to $230,000. You are underwater to the tune of $55,000.
Being underwater makes it nearly impossible to refinance your mortgage. Again, no reasonable mortgage lender is going to write a loan on a home's value that doesn't even come close to the mortgage amount. It's unfortunate, but many homeowners who find themselves underwater are left to ride things out and hope for the best in the future. Even President Obama's plan to help underwater mortgage holders a few years ago has proved largely unsuccessful. It is too risky for lenders so they're not going to do it.
Credit Score
Now, more than ever, a good credit score is vital for refinancing your first mortgage. To get the standard FHA loan most banks will require a minimum score of 620. That score is not hard to achieve, but if you're already strapped for cash it might be tough to maintain. A couple of late credit card payments here and there, combined with a late or missed mortgage payment, and you can forget about a 620 credit score.
The credit score issue is one that unfortunately is part of a downward spiral for many homeowners. Today's refinancing consumer is generally a person looking into this option because he is short on cash. Refinancing is his way to get lower monthly mortgage payments so that he has cash for other things.
But by the time a homeowner goes down this route, he's usually had financial trouble for several months at least. During that time, missed and late payments have reduced his credit score and made it more difficult for him to get a refinancing loan. Without the loan the financial problems continue, the credit score gets worse, and the cycle goes on.
Equity
Knowing your equity is key to securing a good refinancing package. If your finances are such that your credit score and income will not be prohibitive to refinancing, then the next most important factor in determining the terms of the loan package will be your home's equity.
If you've built up a substantial amount of equity, say 20% or more, you should be able to refinance without the need for a new appraisal. This is especially true if you're going through Fannie Mae or Freddie Mac. Refinancing a Veterans Administration mortgage usually affords similar benefits.
Having a fair amount of equity also enables you to get a lower interest rate, and may also give you the leverage to have closing costs waived. In case you haven't figured it out, equity is a very valuable bargaining tool when it comes to refinancing. In a perfect world you would want at least 20% equity; you can get away with less however, if you have a creative loan officer.
Don't Go Backwards
One of the biggest temptations in refinancing first mortgage loans is to extend the new mortgage 30 years in order to reduce monthly payments. This is a bad idea because you simply add more interest to the total amount of money you will pay. For example, if you've only been paying your existing mortgage for 3 to 5 years, you may as well go back to 30 in order to maximize your cash situation. But if you've been paying on your mortgage for 6 years or more, try for either a 15 year or 20 year mortgage instead.
This may not necessarily help your cash situation but you will pay off the house quicker and in the end, pay substantially less interest. If you're right in that bubble area where going backwards doesn't make sense, but you can't afford a 20-year mortgage, perhaps cutting your expenses somewhere else or taking a second job for the time being is a better option.