SANTA CRUZ (December 21, 2008) - The big news this week was headlined in the Wall Street Journal on Wednesday morning: “Fed cuts rates near zero to battle slump”. More often than not, a Fed cut in the Fed Funds Rate has created upward pressure on the long term 30 year fixed rates because a rate cut is usually considered inflationary. That may not be the case this time because there is more fear of deflation than inflation. While we hope that the trend for rates will be moving down, volatility in 30 year fixed rates will continue to be a reality.

Just like in 2003 when rates hit 40 year lows, this drop in rates will provide the opportunity for homeowners to lower their payments, shorten the term of their mortgage and/or create cash. There are two notable differences that homeowners are facing this time around. In order to refinance, a home must have sufficient equity and a homeowner must have adequate income.

Falling values have reduced homeowners’ equity positions and made refinancing a challenge in many areas of our country. Santa Cruz County is certainly not immune. While it is possible to obtain a new loan up to 95 percent of a home’s value, the best rates will be available when loan amounts are no more than 75 percent of the home’s value.

It is frustrating for all of us that even those homeowners who make their payments on time and have great income cannot qualify to obtain a lower rate because they do not have enough equity in their home. When the value of the home is inadequate to refinance the only solution is to lower the loan amount by injecting cash.

The rules have changed regarding underwriting. Income documentation is now mandatory. Homeowners who obtained their current mortgage(s) without providing income documentation may not be able to document adequate income to qualify for a refinance. The critical issue is the Debt-To-Income ratio (DTI). This measurement is obtained by dividing the borrower’s monthly debts, including their Principal, Interest, Taxes and Insurance (PITI),  by their gross monthly income (or net profit if self employed).

Despite the fact that virtually all loans in the U.S. are approved by either a Freddie Mac, Fannie Mae or FHA automated underwriting system, there can be quite a discrepancy between loan approvals. Some loan officers are either not familiar with current underwriting guidelines, incapable of reading tax returns and calculating income or the banks they work for have their own stricter guidelines. Homeowners are well advised to seek a second opinion if they are in doubt about their options.

For those who are fortunate enough to owe less than $417,000, the DTI may go up to 60 percent. If the loan amount is over $417,000, the DTI for conventional loans may not exceed 45 percent. That can make quite a difference. Once again, the only solution may be to pay down the mortgage balance to that magic $417,000 level.

Homeowners who want to take advantage of these historically low interest rates should first make a decision on who they will count on as their mortgage professional and then get the refinance process started. Those borrowers who have their refinance pre-approved are going to be ready to lock in a great rate.  To obtain that approval, we will need to order and receive the completed appraisal, open escrow and review all of your asset and income documentation. If the mortgage industry gets really busy, these refinance approvals can take 2 - 3 weeks or more to complete.

This column is written every Sunday by Peter Boutell, Certified Mortgage Planner and a principal at Santa Cruz Home Finance. You may reach him at (831) 425-1250 of email him at Peter@SantaCruzHomeFinance.com.