A Refinancing Catch-22

You probably already know more than you ever wanted to about the subprime lending mess that big swaths of our economy are mired in. It's caused major headaches for large financial companies, including Merrill Lynch (NYSE: MER  ) , Bear Stearns (NYSE: BSC  ) , and Lehman Brothers (NYSE: LEH  ) .

It's also caused major headaches for millions of mortgage holders, and I have more compassion for them than for lenders like Citigroup (NYSE: C  ) and Capital One (NYSE: COF  ) . After all, much of the mess is tied to lenders having loaned money to people who were not well-positioned to pay them back. In such situations, who has more information -- the lender or the would-be borrower? Well, the lender is sitting on gobs of data about all kinds of loans and the creditworthiness and repayment rates of various would-be borrowers. The would-be borrower has perhaps taken out a mortgage once or twice in his past, or, likely, is trying to borrow for the first time to buy a home.

Saved by refinancing?
So now that they're in this mess, what can someone with an unwieldy mortgage do? For many, their best hope is to refinance into a more affordable loan. For instance, you might replace an adjustable-rate mortgage (ARM) that's set to have a big increase in payments with a fixed-rate mortgage. Also, you could replace a 30-year mortgage with a longer-term one, although 40-year loans have their own problems.

I read with interest recently a piece at, wherein Michael Shedlock opined: "Refinance relief and lower mortgage rates are starting to become available, but only for those who least need it." How true this is. If your spouse is suddenly out of a job, for example, you'll likely have trouble meeting your mortgage payments. Refinancing might be a way to save your skin, but your lower household income will likely prevent you from finding a good deal -- or any deal at all. Meanwhile, if you borrowed $200,000 to buy a home that's now worth $180,000 thanks to a declining market, lenders aren't going to want to loan you more than your house (read: collateral) is worth. And if your credit rating has worsened because of the downturn, lenders will probably only offer you loans at steep interest rates.

Still, you shouldn't give up without trying. There are Federal Housing Administration (FHA) loans available to those with less-than-perfect credit, for example. Some lenders may still offer you a competitive loan, even if it's not at the lowest rate in the market. Consider tapping the services of a mortgage broker, too.

Good news
Meanwhile, if you've got a good credit rating, reasonable debt levels, some accumulated home equity, and ample income, you may find yourself a very desirable customer. According to Eileen Ambrose in the Baltimore Sun, you're "in the driver's seat now. ... If you're thinking about trading in your old mortgage for a new one, you likely can count on better service now. Some mortgage experts suggest you might even have enough leverage to get fees waived or even negotiate a slightly lower interest rate."

You don't even have to be perfect. Ambrose notes that a score of 680 or higher on the FICO scale (devised by the folks at Fair Isaac (NYSE: FIC  ) ) is enough, and that according to Fair Isaac, "half of consumers have a score of 720 or higher."

Bottom line
So go ahead and look into refinancing. It has helped many millions. Just be prepared for some headaches if your situation is less than ideal.

Learn more about refinancing in our Home Center and in these articles:

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Selena Maranjian

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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