Mortgages: What You Need to Know in 2009

You have to go back to around 1961 to find a time when 30-year mortgages had rates this low, according to Keith Gumbinger, a vice-president at financial publisher HSH Associates in Pompton Plains, N.J. For that, thank the U.S. government, which is trying to jump-start the stalled housing market by buying up mortgage-backed securities.

Rates are probably headed even lower in 2009, raising the question of whether you should borrow now or wait for a better deal. The experts are sharply divided over this one. Put it this way: If you're a gambler, wait. If you can't sleep at night worrying that rates will go up from here, borrow now.

Here are some key things you need to know about today's mortgage market:

Now More Than Ever, Shop Around

In ordinary times, one loan is about as good as another because most lenders' offers on 30-year loans are clustered within around a quarter of a percentage point. Not now. With the economy so shaky, lenders are all over the map in how much risk they're willing to take in making loans. So it really pays to shop around. And keep checking, because rates are constantly changing. One day in late December 2008, Wells Fargo was offering 30-year conforming loans at 5.0% plus one point, while Bank of America was offering the same kind of loan at 6.625% plus one point, according to Cameron Findlay, chief economist of LendingTree.com, a division of Home Loan Center. No offense to Bank of America, but only a sucker would have borrowed from it instead of Wells Fargo that day.

For New Loans, Get a Fixed Rate

Forget what you were told in quieter times about the pros and cons of fixed- vs. adjustable-rate mortgage loans. These days, all the best deals are on fixed-rate loans because that's the segment of the market that the government has been targeting with support. The securitization of adjustable-rate loans has mostly dried up, so banks don't want to originate ARMs, therefore they don't offer attractive rates on them, says HSH's Gumbinger.

If You Have an ARM, Keep It for Now

On the other hand, if you got an ARM in the past and it's coming up on an interest rate reset, don't rush to unload it. Short-term interest rates have gotten so low that you're very likely to see your monthly payment fall. Thank your lucky stars if your ARM happens to be indexed to the one-year Treasury bill, whose yield has fallen below half a percent. Even with the typical spread added on, you're still paying only around 3.25% a year, says Gumbinger. ARMs indexed to LIBOR (the London Interbank Offered Rate) are resetting these days to the low 4s, which is still excellent.

Check Your Finances

The hurdles to get one of those low fixed-rate loans are high because Fannie Mae and Freddie Mac have tightened standards for the loans they'll buy or guarantee, even though the two mortgage finance giants are now under government conservatorship. You'll need a FICO score of at least 720 for the best interest rate, although for a big enough fee Fannie and Freddie will guarantee loans with FICO scores down to the mid-600s. You may also need a down payment of 20%. In the boom times you could get a "piggyback" loan to shrink your down payment, but those are history. Even private mortgage insurance, which used to cover some of the financing gap up to 20%, is much harder to get now because the issuers have suffered big losses.

Lately, says LendingTree's Findlay, the highest hurdle for many buyers has been lenders' debt-to-income standards. Here are the numbers, as of late December, according to LendingTree: For a Fannie or Freddie conforming loan, monthly mortgage payments cannot exceed 28% of gross income, while all debt payments (including student loans, etc.) cannot exceed 36% of gross income.

For a Federal Housing Administration-guaranteed loan, the corresponding figures are 29% for mortgage debt and 41% for all debt.

Before Making an Offer, Get Pre-Qualified

Home sellers are likely to give you a better deal on a house if you're pre-qualified for a mortgage. Why? Because it shows you can get the deal done quickly. In this market, nothing burns a seller more than being strung along by a buyer who wants the house but can't qualify for a loan to buy it.

First-Time Borrowers: Get Credit Counseling

A lot of the mess we're in now could have been avoided if first-time home buyers had paid attention to warnings about getting overextended. If you don't want to listen to your parents or nosy brother-in-law, then visit a credit counseling agency. Says Rick Sharga, marketing vice-president at RealtyTrac: "Most people getting into the market for the first time seriously underestimate the cost of maintaining a home, from taxes to upkeep. What happens if that water heater blows? Do you have enough money to pay for it without missing a mortgage payment?"

Think Hard About Refinancing Now

The decision about when to refinance comes down to personal risk preferences. Of course, you should also run your numbers through one of the many online calculators (a rough rule of thumb is that it makes sense to refinance if the new rate is a full percentage point below your current rate and you don't plan to move soon).

The argument to wait, as expressed by BanxQuote.com President Norbert Mehl, is that the Federal Reserve and Treasury Dept. are determined to force mortgage rates lower in 2009 and are bound to have their way. Says Mehl: "The pressure on the banks will continue to mount to bring down interest rates, not just on mortgages but on all kinds of personal loans."

In contrast, LendingTree.com's Findlay says that while it's reasonable to guess that rates will fall more, nothing's for sure. "Rates have come down so fast that trying to pick the bottom is a mistake," he says. "Their propensity to slingshot back up is high." He votes for refinancing now if the numbers work.

Mortgage Refinancing

If you are a homeowner, now might be a good time to think about refinancing your mortgage.

Refinancing is when you apply for a secured loan in order to pay off another different loan secured against the same assets, property etc. If this original loan had a fixed interest rate mortgage which has now declined considerably, then you would like to avail of a new loan at a more favorable interest rate.

When is Refinancing an Option
Typically home refinancing is done when you have a mortgage on your home and apply for a second loan to pay off the first one. While taking the decision to go for the home refinancing option, it is important to first determine whether the amount you save on interests balances the amount of fees payable during refinancing.

Benefits of Home Refinancing
Imagine a scenario where you can have access to extra cash, while simultaneously lowering your monthly mortgage payment. This dream can become a reality through mortgage refinancing.

A house is the largest asset you may ever own. Likewise, your mortgage payment may be the largest expense you'll have in your monthly budget. Wouldn't it be great to use this asset to reduce your monthly payment and put extra cash in your pocket? When you refinance your mortgage, you can take advantage of the equity in your home and enable this to take place.

Lower Refinance Rate, Lower Payments
When you purchased your dream home, the financial environment dictated interest rates. While certain factors, like your credit rating and the amount of the down payment that you were able to afford, influenced your interest rate, the single most important factor was the prevailing rates at that moment. However, interest rates fluctuate. When the Federal Reserve enters a rate-cutting period, the prevailing rates may become significantly lower than when you originally purchased your home.

By refinancing your mortgage when interest rates are lower, you can exchange a higher interest rate for a lower one, which, in turn, will lower your monthly payment.

Shorten the Length of Your Mortgage when Refinancing
Another advantage of home refinancing is that you can shorten the term of your mortgage. Let's say, for example, that you originally had a 30-year mortgage and have been paying it for eight years. Thanks to mortgage refinancing, you can switch to a shorter term of either 10, 15 or 20 years. This can save you thousands of dollars of interest. Also, if the refinance rate is lower, but you maintain the same monthly payment, you will build up equity in your home more quickly, because more of your payment will be going towards principal.

Exchange an Adjustable Rate for a Fixed Refinance Rate
When interest rates are low, adjustable rate mortgages (ARMs) are the housing market's darlings. However, as interest rates increase, that adjustable rate may not look as sweet. It's also possible that you opted for an ARM because your financial future was less secure, or you weren't sure how long you'd stay in your home. If, however, you've become financially stable and know that you'll be staying in your home for several years, it may be beneficial to swap that fluctuating adjustable rate for a fixed one. You'll have more security knowing that your monthly payment will remain steady, regardless of the current market environment.