In forbearance and want to refi your mortgage? Here’s what to do

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When the coronavirus recession hit, millions of American homeowners embraced a generous break from the federal government, one that let borrowers miss mortgage payments for up to a year with no penalties.

Forbearance programs accomplished their goal of averting a foreclosure crisis, but the program carries a notable downside: If you’re not making payments, you’re not eligible to refinance your mortgage. With mortgage rates on the rise and a historic refi window narrowing, you’ll want to exit forbearance as quickly as your finances allow.

If you requested forbearance from your lender but continued making your mortgage payments as usual, the fact that you were in forbearance doesn’t matter. You can still refi, says Jess Kennedy, chief operating officer of mortgage company Beeline.

If you’ve missed payments, however, making a smooth exit from forbearance and into a refinance becomes “relatively tricky,” Kennedy says. “Because the rules are so nuanced, it depends on each person’s particular circumstances.”

In other words, contact your mortgage servicer to make sure you understand the rules and how they affect your situation. Some lenders are offering flexible terms that let borrowers quickly return to the refi market even if you have skipped payments.

Get back on track for three months

The broadest guideline is that, if you’ve missed payments, you need to make three monthly payments on time before you can exit forbearance and become eligible for a refi. Those are the rules laid out by mortgage giants Fannie Mae and Freddie Mac, the biggest players in the U.S. mortgage market.

“The idea is to make sure the borrower has the financial stability to make payments,” says Ziggy Jonsson, head of financial products at mortgage company Better.com.

The rules for exiting forbearance can be a bit different if you have a jumbo loan or a mortgage backed by the Federal Housing Administration, the U.S. Department of Veterans Affairs or the U.S. Department of Agriculture. While each program has its own rules, lenders generally have taken their lead from Fannie and Freddie when it comes to entering and exiting forbearance.

Keep in mind that a refinance is a new mortgage with a new approval process, and your eligibility to refinance depends on more than simply leaving forbearance. The refi lender also will scrutinize your credit score, your income, your debt-to-income ratio and your loan-to-value ratio.

Rising home values mean loan-to-value ratios aren’t an issue for most refi borrowers. But if you took a financial hit during last year’s downturn, that could complicate your ability to refi.

You still owe missed payments

Forbearance programs let you miss payments with no hits to your credit score, no penalties and no requirements for lump-sum payments. However, you still owe the unpaid principal and interest.

Say your mortgage is a 30-year fixed-rate loan for $300,000 at 4.25 percent. Your monthly payment is $1,476.

Assume you missed six payments. If you don’t refi, those payments simply are added to the end of your loan. If you want to refi, however, those six payments, totaling $8,856, will be added to the amount of your payoff.

If you’re considering refi options, here’s how the scenarios might break down:

Original loan

  • Amount: $300,000
  • Rate: 4.25 percent
  • Payment: $1,476

New loan

  • Amount: $308,000
  • Rate: 3.25 percent
  • Payment: $1,340

In this simplified example, you could save $136 a month by refinancing. Is it worth it? That depends on how long you plan to stay in the home, and how much your closing costs are.

If you keep the loan for a decade, the $16,320 in lower payments should more than offset closing costs for the refi. If you move in a couple of years, however, refinancing doesn’t make sense — you’re unlikely to recoup your closing costs through lower monthly payments.

What you can do

To score the best deal on a mortgage:

  • Shop around. Closing costs and rates vary by lender, so get three bids — and more if you can.
  • Even after you’ve found the best deal, push for more — a better rate, or concessions on closing costs.
  • Understand the breakeven point. That’s the moment at which the savings in monthly payments offset the amount of the closing costs. This refinance calculator can help you decide.
  • Don’t chase the lowest rate. Yes, a low rate and paltry payment are good, but make sure those benefits aren’t overwhelmed by steep closing costs.

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Written by
Jeff Ostrowski
Senior mortgage reporter
Jeff Ostrowski covers mortgages and the housing market. Before joining Bankrate in 2020, he wrote about real estate and the economy for the Palm Beach Post and the South Florida Business Journal.