Should You Refinance?

With mortgage rates at or near record lows, you might be thinking about refinancing -- and you wouldn't be alone. Both Bankrate.com and LendingTree.com report that there has been a surge in homeowners looking to refinance. And many lenders are seeing borrowers who want to switch to shorter-term mortgages such as a 15-year loan because the average rate has reached a record low of 3.58%.

Payments on a shorter loan typically are higher, but you can save big on interest payments. To find out whether it makes sense to shorten your term, see Downsize Your Mortgage?.

Whether you want to shorten your term or just lock in a lower rate, be prepared to jump through a lot of hoops if you refinance. Here's what you need to know (and consider) before you head to the bank.

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You need a good credit score. To get the lowest rate, you need a credit score of at least 720 and 20% equity in your home. Even so, those with high credit scores have to pay more now for mortgages than they did earlier in the year. In April, Fannie Mae increased the adverse market charge on home loans and started requiring all borrowers, even those with a credit score of 740 or higher, to pay this fee. See Expect to Pay More for a Mortgage for more information.

You need plenty of documentation. When you apply to refinance, be ready to provide pay stubs from a recent month, two months of bank and other financial statements, two years of W-2s and, if you're self-employed, two years of tax returns showing self-sustaining income. When my husband and I refinanced our mortgage recently, I had to show my most-recent contract with Kiplinger's (because I am a contract worker rather than full-time employee). And if you have a home-equity loan or line of credit, your current lender will have to document its willingness to "resubordinate" to your new first mortgage -- that is, stand behind the first lender for compensation if you default.

You should shop around for the best rate. Rates on average are low. Even so, you want to make sure you're getting the best rate you can. Start by checking with your current lender to see what sort of rate you can get. Then call other lenders, including credit unions and mortgage brokers, and check online at sites such as LendingTree, where lenders compete to offer you loans, and Mortgage Marvel, which provides real-time rate quotes offered by participating lenders who do business in your area. Get good faith estimates from lenders to compare offers before you formally apply. You don't have to pay to get a GFE, but you might have to pay for the lender to check your credit report.

You need to look at all the numbers before refinancing. When comparing offers, don't stop at the interest rate. Also look at the cost to originate the loan and third-party fees (such as taxes and title costs). If you don't plan on staying in your home long, the costs of refinancing might outweigh the savings. The calculators at Mortgage Professor can help you run the numbers.

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