On the Fence About Refinancing?

David Politis was struggling with his home's towering interest rate when he settled on a strategy for saving money: refinancing. But first, he had his work cut out for him.

"We had terrible credit scores a few years back," says Politis, president of Politis Communications in Draper, Utah. "After discussing our finances with our son-in-law, a loan officer who works for a mortgage broker, we made sure we made all of our house payments on time for 12-plus months -- as well as everything else." That smart step got Politis and his spouse back in the good graces with the credit bureaus, and into a fixed-rate Federal Housing Administration loan.

A year later, with an extended good-payment history, Politis pushed a streamlined refinancing through with FHA. His new rate: 5.75% fixed -- down from 9.85% fixed, and a huge improvement over his 13.99% variable rate. The Politis family, now saving more than $300 each month, plans to parlay the savings to pay down consumer credit. It all came down to striking while the iron is hot: cashing in on a great opportunity to refinance last summer.

To refi, or not to refi? If you're on the fence, wondering whether to refinance now with rates near historic lows, or wait it out to see if rates drop further, Woody Alpern, a CPA and cofounder of Capital Investment Advisors, is unequivocal: "Now is the time."

Here's why: the first time homebuyer's credit has now been extended, through sales contracts written by April 30 and closed by June 30. That credit has been reduced to $6,500, but the adjusted gross income limit was raised, so many more buyers qualify. "We're still near all-time lows, but eventually inflation will come back, and rates will creep up," Alpern says. "Don't try to guess the bottom. We may have already hit it."

What does "historic lows" really mean? Mortgage rates fluctuate day-to-day, based on the performance of the bond market, because that's where they correlate, says Karie N. Herring, senior consultant at Southwest Direct Mortgage in Scottsdale, Arizona. It all depends on supply and demand.

"Mortgage rates have gone as high in the past as 10%, 12%, or higher, especially in the 1980s," Herring says. "Historically, rates now are super-low. You're looking at 5% to 6%, where 20 and even 10 years ago, we were still pushing upwards of almost 10% for a standard conforming loan. Right now, for a standard 30-year conforming mortgage, you're looking at 4.875% -- still fairly phenomenal."

But such low rates are reserved for a customer with a strong credit score of at least 720, Herring says. Beneath that, the rates would rise a little bit —- a quarter of a percent, or maybe an eighth, depending on your credit profile and how big a loan you're seeking.

A low credit score can keep you from taking advantage of these record lows, Alpern says. "More than ever, banks are being very careful about who they lend to. The days of 'stated' income -- when you didn't have to prove what you earned -- and lending to those with credit scores below 700 are pretty much gone," he says. "Banks have lost literally billions of dollars by making bad loans, and they now have ramped up their lending guidelines significantly." That's why it's that your credit is flawless.

If you have even one blemish on your credit report -- say, you paid a credit-card bill late -- be prepared to write a detailed explanation of why it's there, and how you've taken measures to ensure it won't happen again. Some underwriters accept a one-time slip and override their guidelines to get you the preferred rate, Alpern says. But in general, the better your credit, the better the rate you'll get.

But all's not lost if your credit score is less than stellar. Refinancing options still exist. "People who are shooting for that 4.875% are shooting for something that isn't always obtainable," Herring says. "If you have a credit score of 620 or 640, you can still get a low rate. You're going to get a lot better rate than you could have a couple of years ago. We still have the FHA lending program -- ideal for folks who may not have perfect credit, but who do pay their bills."

Before you refinance, get your paperwork in order and make sure you're prepared for full-documentation loans. You'll need to provide proof of income, W-2s, and your prior three years' tax returns, Alpern says. Alpern also advises you don't carry more than three mortgages, including any rental property you may have; new guidelines prohibit approval for Freddie Mac or Fannie Mae mortgages for anyone with more than three mortgages in their name.

If you're hesitant, talk to a local mortgage broker or a banker who can provide you with interest rates and a quoted payment. You can also compare quotes from different banks online, so you can review all options.

But above all, you should decide whether refinancing makes sense for you. Even though the rates are low, Herring says, be sure you're reducing your interest rate by at least one percent. Using that industry standard as a guideline, the cost effectiveness of a refi -- boosted by new options and availability -- may work out to your benefit.

Janene Mascarella is a New York–based freelance lifestyle writer. Her work has been published in The Washington Post, Self, Glamour, Woman's Day, Parenting, Parents, American Baby, American Way, and many other publications.