It's a good time to refinance, but do your homework

Mortgage rates are at rock-bottom lows. Yet declining numbers of people are applying to refinance their mortgages.

Regardless of the reasons for the dwindling number of refinancers, this is a good time to at least consider a refi. Here are three things you need to know when you’re thinking about refinancing, plus two dos and one don’t as you navigate the refinancing maze.

First, know how much your house is worth compared to how much you owe.

You probably already have a fairly accurate idea of how much you owe on the house. If not, you can check your last annual statement from the mortgage company, read a recent invoice or call the servicer and ask. Or ballpark it. You don’t need to know the outstanding principal balance to the penny.

Then you need to estimate how much the house is worth. If you’ve been paying attention to home sales in your neighborhood, you probably have a general idea. You also can ask a real-estate broker for an estimate.

Divide the home’s estimated value by the amount you owe. If you owe $80,000 and the house is worth $100,000, then you owe 80 percent of the home’s value. If you owe $120,000 and the house is worth $100,000, then you owe 120 percent of the value.

Do your calculation, then write down the percentage on a piece of paper under the heading: “Estimated loan to value.”

Next, know whether you have a second lien. Do you have a home equity loan or home equity line of credit? If so, find out how much you still owe on it.

Add that amount to the amount you owe on the main mortgage. Take that combined amount, and divide it by the home’s estimated value. For example, if you owe $80,000 on the first mortgage and $10,000 on the home equity line of credit, you owe a total of $90,000. If the house is worth $100,000, then your total debt on the house is 90 percent of the home’s value.

Do your calculation, then write down the percentage under the heading: “Estimated combined loan to value.”

When you ask about a refi, the lender will want to know these two percentages.

Lastly, know whom to call.

To find the right party, ask yourself if the loan to value is more than 100 percent. In other words, do you owe more on the first mortgage than the house is worth? If so, your first call should be to that mortgage servicer. You probably are a candidate for the Home Affordable Refinance Program, or HARP. With a HARP refi, your best bet is to apply with the current servicer.

Is the loan to value 90 percent or less? Most mortgage brokers and lenders will be able to help you. Call the current servicer, or get a referral to a broker or lender.

Are you in the no-man’s land between 90 percent and 100 percent loan to value? You can try elsewhere, but probably should start with the current servicer. Armed with the right information, here are two steps to take and one to avoid.

Do document all your assets. You must be especially thorough if you owe more than the house is worth.

“Let your loan officer know about all the assets you have,” says Michael Becker, mortgage consultant for Green Pastures Mortgage & Finance in Lutherville, Md.

“This includes retirement accounts, mutual funds, stocks, bonds, trust funds and monies in savings and checking accounts. I have found it hard to get an approval on a high loan-to-value loan without a good amount of reserves.”

After documenting your assets, do refinance for the same term as your outstanding loan.

Think of your mortgage as a building that’s 30 stories high (or, if you have a 15-year mortgage, the building is 15 stories high). Your goal is to pay off your house by getting to the top of the building, one floor at a time.

With a refinance, don’t start again at the bottom floor. Stay on the same floor. Keep climbing from there.

Let’s say you are five years into a 30-year mortgage, and you’re refinancing into another 30-year mortgage. You planned to pay off the old mortgage in 25 years, so you should plan to pay off the new mortgage in 25 years, too.

If you want this all to work, don’t buy a big-ticket item or get another loan before closing on the refi. Avoid making any major financial moves until after the refinance is closed.

“Sometimes people will go out and make a major purchase, like a car, in anticipation of the monthly savings they are going to reap from their refinance,” Becker says. “Unfortunately, this can sometimes raise your debt-to-income ratio to a level that would cause you to be denied the loan.”

Less drastically, a big purchase “could lower your credit score to the point where you would have to pay more in fees or get a higher interest rate,” Becker adds. “Wait until after the refinance is closed and funded to do anything that might change your credit profile.”