Back to Fundamentals: How do I know how much mortgage payment I qualify for?

By: Evan Vanderwey
Michigan Mortgage

The answer to this question defines the “simple but not easy” category of mortgage education if ever there was such a category.

Simply put – you take your gross monthly income, multiply by around 40% (0.40), subtract from that number the amount of the minimum payments on all of your other debts, and the resulting number is the amount of your maximum house payment. Lastly, the house payment must include the principle and interest amount, property taxes, home owners insurance, and association dues if you are buying in a condominium complex.

Simple.

Except for one thing: What does the lender consider to be your gross monthly income?

Here’s a little help if you’re trying to calculate your gross monthly income. But if you are serious about putting in an offer on a home, there is no way a seller or your REALTOR® will trust your own calculations. In this market, if you’re using a mortgage, you will be required to talk with a lender who will sign off on your math ahead of time.

If you are employed and are paid a salary then you take your gross annual salary and divide by twelve. This is your monthly income.

If you are paid a bonus annually – you take the last two years’ amounts, add them together and divide by 24. Unless your most recent year’s bonus is less than the one you got two years ago – in that case, you take the last year’s amount and divide by 12.

If you earn overtime, consider ignoring it when it comes to setting your personal budget. But if you need to include it to qualify for the mortgage, then it must be increasing from year to year and then you take a 24-month average of the amount of overtime you earned.

Commission-type income must be taken as a 24-month average as well and can be used only if the income is increasing over the past two years. Under certain circumstances, declining income may be used, but only the lower of the two years is used in the calculation. Tax deductible expenses that are deducted on the person’s tax return (form 2106) must be removed before calculating the “gross taxable income.”

Self-employed borrowers must be able to show two years of income as well. We must see an increasing income pattern in most cases. Depreciation can be added back into this number. I cannot stress enough the importance of working with a knowledgeable loan originator if you are self employed. Your income must be calculated accurately up front or even the most well-qualified borrowers can find themselves with a difficult situation during the loan process.

For bonuses, overtime, commissions, and self-employment income, the borrower must have been in the same exact job for the past two years. You can’t move from GM to Fiat for example and average the last two years’ overtime over two separate employers.

Rental income from a tenant can be added in at 75% of the amount of the rent once there is 12 months of history of the tenant paying on time. We can also use the schedule E of a borrower’s tax return to verify rent – this takes the income from tenants and subtracts the expenses from that investment property. The net income on schedule E can be used after one year of having received the rent. Depreciation again is a non-cash expense and can be added back to net income.

Fixed income from settlements or awards, like child support and disability, pension or social security income, is all usable income. We use the full amount as gross monthly income so long as it can be proven that there are three years left for child or spousal support payments. There must be at least 12 months of proof that the payments have been received.

The above list is not meant to be exhaustive but instructive. Calculating income correctly for a lender is no easy task. Take this seriously and work with a qualified lender ahead of time.

Affordable Housing That's Green, Too

Green Building Goes on a Budget

Thanks to tax credits and cost cutting, more affordable housing projects are turning eco-friendly

By ROBBIE WHELAN
Wall Street Journal, 10/18/10

Casa Feliz, an apartment building that opened last year in San Jose, Calif., was built with modern finishes and the latest in trendy, environmentally friendly materials: bamboo floors; organic, linseed oil-based linoleum tiles; and ergonomic chairs in the lobby made from sustainably farmed wood.

But in what might come as a surprise to some, no Prius-driving, Dwell magazine-reading, upper-middle-class professionals reside there. The project was built for people who earn less than 35% of San Jose's median income of $103,500 for a family of four, or suffer from developmental disabilities.

Casa Feliz is one of a growing number of affordable-housing projects nationwide that have been built "green"—that is, with nontoxic materials, highly energy-efficient appliances, and features such as green roofs and solar panels. Thanks to tax credits designed to attract private capital and aggressive cost-cutting on other construction features, affordable-housing developers are embracing eco-friendly building features that were once the purview of high-minded designers and wealthy developers with money to spare.

A Better Deal

Dana Bourland, a vice president with Enterprise Community Partners Inc., a Columbia, Md.-based nonprofit that helps finance affordable-housing projects, predicts that the affordable-housing industry will be 100% green by 2020. Not only are green buildings better for the environment, but they make better financial sense, too, she says, because they come with lower water and energy bills and lower tenant-turnover rates.

As such, investors view them as safer investments than buildings without such features, she says.

"The underwriting is changing," she says. "I think there's a growing recognition that these are better deals."

Most affordable-housing projects, including green ones, rely on the federal Low Income Housing Tax Credit, a Reagan-era program that provides incentives for corporations to invest in housing for the poor. Corporations purchase the credits—which are administered through a state-by-state allocation—and use them to take a credit against corporate taxes on their profits. Big investors over the past decade have included banks, insurance companies and the government-supported mortgage giants Fannie Mae and Freddie Mac.

After the housing crash and the collapse of Fannie and Freddie, the market for these tax credits softened considerably, and affordable-housing developers were forced to offer investors higher yields. Some corporations paid as little as 60 cents on the dollar for the credits, which meant developers had less money to put toward energy-saving features that earn buildings green plaudits.

But builders and investors say the market is coming back. Jeff Oberdorfer, executive director of First Community Housing, the San Jose-based nonprofit developer that built Casa Feliz, says investors are paying about 75 cents for each dollar of tax shelter now, and they are eager to underwrite green buildings because of the energy cost savings.

Investors are "starting to become more sensitive to the lower costs, the higher cash flows from energy savings," Mr. Oberdorfer says.

MetLife Inc., the big New York-based insurance company, is one of those investors. Matt Sheedy, who invests funds from MetLife's $325 billiongeneral account, says MetLife and other large institutional investors are eager to invest in green affordable-housing projects because they have a safer risk profile than more traditional housing projects.

"Investors commonly accept moderately lower returns for lower risk profiles, and green features are more in demand," he says. "I don't think we're back to peak prices, [but] this year, investor demand has picked up."

MetLife bought $14.3 million in credits on First Community Housing's Fourth Street Apartments project, a 100-unit affordable-housing building going up in downtown San Jose, and has also invested in Bay Avenue, a 109-unit senior-housing project in Capitola, Calif. Both projects are green. All told, MetLife has invested more than $1billion in affordable tax-credit projects since 1995, many of them green, Mr. Sheedy says.

Freeing Up Funds

Developers are going full speed ahead on green affordable-housing projects elsewhere across the U.S.

Enterprise Community Partners, for example, has invested more than $500 million in green tax-credit projects and recently launched a $50 million investment fund geared toward renovating low-income projects with eco-friendly features. In Utah, Enterprise is close to a multimillion dollar deal with American Express Co. to invest in green affordable tax-credit deals, according to Ms. Bourland, the vice president. American Express didn't respond to requests for comment.

New York builder Jonathan Rose Cos., meanwhile, is building $750 million of green affordable-housing projects and manages about $1.3 billion in completed green projects. It opened its latest apartment building in September.

Castle Gardens, an energy-efficient rental-apartment complex for former inmates and other low-income tenants in New York's Harlem neighborhood, was financed in large part by $16 million in tax-credit equity from Capital One Bank N.A. and other investors. Still, Jonathan F.P. Rose, the builder's founder and director, says his company had to work hard to free up money to make the complex green.

Up on the Roof

Rose saved almost $100,000 by putting gas-fired hot-water boilers on the roof rather than in the basement of the building, as is typical. That allowed it to avoid building a pricey flue that would have had to run from the ground to the top of the structure to pump out exhaust fumes. In addition, the windows in each room have "trickle vents" that encourage airflow and cool the apartments in summer, but are cheaper than a central venting system. The money saved allowed the builder to add features that made Castle Gardens 30% more energy-efficient than other buildings of comparable size in Harlem.

"In the early to mid-1990s, as a few voices were beginning to emerge and push for the greening of affordable housing, the affordable housing community's response was, the need for affordable housing [is] so great that we cannot defer any money from the quantity of the units to the quality of the project," Mr. Rose says.

That was excellent discipline, he adds, because "the green affordable housing had to grow up with no money to spare."

Mortgage Rates Would Lose at Limbo - They're About as Low as They Can Go

Wall Street Journal, Oct. 12 2010
By PRABHA NATARAJAN

Mortgage rates have hit another record low—4.27% on average for 30-year fixed-rate loans, according to Freddie Mac—but analysts and others say home-loan rates are much higher than they should be.

Don't bet the house, however, that they will drop too much lower. Rates haven't fallen further, analysts and bankers said, because banks are unwilling to lower rates and lose profit margins, and because of uncertainty in the market that makes it difficult for them to predict the number of home buyers.

Instead of moving the rate lower to 4%, which banks might have done at "normal times" when bond yields are as low as they are, "illiquidity and unusual situations are causing originators to hold rates at this level rather than risk losing money on new loans they have difficulty hedging," said Paul Jacob, director of research at Banc of Manhattan Capital, in Manhattan Beach, Calif.

Based on the yields of mortgage-backed securities traded on secondary markets, David Cannon, head of mortgage trading at Royal Bank of Scotland Group PLC, says that the mortgages in Freddie Mac's weekly survey should come with interest rates between 3.75% to 4%.

At those lower rates, a homeowner could lower his monthly payments on a $200,000 loan by $30 to $60—saving nearly $22,000 over the full life of a 30-year mortgage.

Moving toward the theoretically lower rate isn't a simple matter, however. There is a convoluted scenario at work that goes at the heart of how mortgages are bundled together and packaged into securities that are sold to investors.

Typically, local and regional banks lend to homeowners, then sell those loans to larger banks or aggregators, such as Citigroup Inc., Bank of America Corp., Wells Fargo & Co. and J.P. Morgan Chase & Co. These firms pool loans from across the U.S. into mortgage securities.

Normally, small banks would push rates as low as they could go in order to make more loans and thus make more money. But they have found that while lower rates may bring in more home buyers, there is little guarantee that many of these consumers will qualify for a loan under today's austere borrowing standards.

Further, these originators make money from the rates at which they can sell these loans to aggregators. Lower rates mean narrower margins for them, while the aggregators who buy these loans at lower rates stand to gain from selling them at higher rates in the secondary market.

Because there are so few new mortgages and so many investors eager to buy them, "the system now allows large aggregators to control the price on a loan and an interest rate the borrower gets," said Mike Delehanty, president of Apex Analytics in Wildomar, Calif., which advises banks on selling their loans to larger mortgage-finance companies.

Mortgage rates usually are based on the yield investors are paid for the risk of purchasing securities backed by home loans, and the premium that the lender charges to service the loan.

Currently, the yield on government-guaranteed mortgage security is 3.206%, and the primary mortgage rate is 1.064 percentage points higher. Historically, the difference is in the range of 0.50 to 0.70 percentage point, according to Amherst Securities Group.

That unusually wide gap indicates that banks continue to make it tough for consumers to get really low rates on loans, as they fiercely protect their gains.Representatives of the country's largest mortgage lenders, including Citigroup, Bank of America, Wells Fargo and J.P. Morgan Chase, declined to comment or didn't return phone calls seeking their views.

Mortgage rates aren't likely to drop significantly even if the interest rate on the 10-year Treasury bond and corresponding yield on mortgage securities drop further.

"Even if interest rate drops to 2%, mortgage rates are going to stay right here," said Paul Norris, a portfolio manager at Dwight Asset Management in Burlington, Vt. "Originators don't expect mortgage supply to be robust and will want to keep rates in the 4.25% to 4.625% range for the next few months."

Should You Pay Off Your Mortgage? The Answer May Surprise You

The following article from the WSJ reveals that it may make sense for you to pay off your mortgage. Here's one reason why: With today's volatile stock market, you can't necessarily guarantee that any funds you have invested will outperform the interest rate you're paying on your mortgage.

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Should I Pay off the Mortgage?

By June Fletcher
WSJ, Oct. 5th 2010

Q: We have a mortgage worth $177,000 on a house that we've owned for 21 years. We've refinanced our loan twice, and now have a 30-year mortgage at 6.48% that we took out in 2002.

My husband and I are now six years from retirement, and we are trying to figure out the best use of our money. We have enough to pay off the mortgage without dipping into our IRAs, and we'd sleep better if we didn't have a mortgage hanging over our heads. Is this a good idea?

—Washington, D.C.

Given the economy's continuing weakness, the fact that you have cash that's not tied up in IRAs and how close you both are to retirement, I think it's a fine idea to pay off your mortgage.

Here's why: You should always try to get the best return possible on your money. So you shouldn't keep the loan unless you can find another investment that, before taxes, can reliably earn more than the 6.48% that you're currently paying on it. With the stock market still volatile and certificates of deposit and other relatively safe investments paying less than the rate of inflation, I wouldn't count on that.

What's more, paying off a mortgage loan is risk-free—no matter what happens to the general economy, you'll be left with an asset that you can live in or rent out.

A downside is that you'll lose the mortgage interest tax deduction if you pay off your loan. But as a new report from the National Association of Home Builders points out, those benefits largely go to those buyers who are younger than 45, who typically have the largest mortgages and the most itemized expenses.

Meanwhile, if you pay off the loan, you'll have plenty of company. According to the latest American Community Survey released by the U.S. Census, there are approximately 50.7 million owner-occupied homes with a mortgage in 2009, compared to about 51.6 million in 2008. Folks are paying off second mortgages and home equity lines of credit, too. Those have dropped to about 12.1 million in 2009 from roughly 13.3 million the year before.

Of course, you do have other options. You can refinance your relatively expensive current loan to today's lower interest rates—but doing so will incur thousands of dollars in closing costs. Or, while you are both still working, you could simply add extra principal payments to your current mortgage and pay it off more quickly.

But if you pay off your mortgage completely, you'll not only sleep soundly, you'll be in a position to get a reverse mortgage should you need to tap into your home's equity at a later date. The way reverse mortgages are structured, the older you are when you take out a reverse mortgage, the more you'll be able to withdraw while still remaining in your home, since your life expectancy declines with each passing year. That's a good fallback should you outlive the funds you manage to put away before retirement.

What to Know About Home-Sale Tax Rules

By TOM HERMAN
Wall Street Journal, Sept. 19th 2010

Q: What are the chances that Congress will ease the rules on how long you have to own your home and live in it in order to qualify for the most favorable capital-gains tax treatment when you sell it?

—K.M., Prior Lake, Minn.
A: Slim to none. Naturally, anything is possible if Congress ever decides to overhaul the entire tax system. But don't count on that happening any time soon.

Even if lawmakers do consider major tax-law changes after the November elections or next year, don't expect them to ease the home-sale rules. I haven't heard any significant discussion of this issue among congressional leaders in many years.

Here is how the basic rules work: In the late 1990s, then-President Bill Clinton signed legislation that officials said at the time would eliminate capital-gains taxes for most people who sell their primary home for a profit. That legislation generally allowed most sellers to exclude a gain of as much as $500,000 (if married and filing jointly) or as much as $250,000 (if single).

To qualify for the full exclusion, you typically must have owned the home -- and used it as your primary residence -- for at least two of the five years prior to the sale. For more details, see IRS Publication 523 ("Selling Your Home") on the Internal Revenue Service website (www.irs.gov).

But don't assume you're out of luck if you can't meet the ownership and use tests I mention above. You still might be eligible for a partial exclusion that could greatly reduce -- or even eliminate -- capital-gains taxes on the sale of your primary home.

For example, you may qualify for a partial exclusion if you had to sell your home because of "a change in place of employment" or if you moved for "health" reasons. IRS Publication 523 has other examples.

Here is what the IRS says it means on the health issue: "The sale of your main home is because of health if your primary reason for the sale is: To obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury of a qualified individual," or to "obtain or provide medical or personal care for a qualified individual suffering from a disease, illness or injury."

Conversely, the IRS says the sale of your home isn't because of health if the sale "merely benefits a qualified individual's general health or well being."

You also might qualify for a partial exclusion if you had to sell for certain "unforeseen circumstances," such as "natural or man-made disasters or acts of war or terrorism resulting in a casualty to your home, whether or not your loss is deductible."

Credit Scores May Hamper Housing Comeback

By Phil Izzo

Homeownership is potentially out of reach for nearly a third of Americans, according to a new report that highlights the difficulties in the housing market in the wake of the Great Recession.

Potential home buyers may be among the hardest hit by the recession. People with a credit score below 620 who went searching for a loan were unlikely to receive even one quote, according to real-estate web site Zillow.com, even if they offered a down payment of 15%-25%. Zillow notes that 29% of Americans has a credit score this low, according to data provided by myFICO.com.

“Today’s tighter credit is a predictable response by banks after the foreclosure crisis, but also keeps a cap on housing demand, which is important for the greater housing market recovery,” said Zillow chief economist Stan Humphries.

While banks may be right to try to avoid repeating mistakes made during the housing bubble, an over-reliance on credit scores could create problems for the real-estate market. Banks shouldn’t be giving mortgages to borrowers who can’t afford to pay them back, but if people with sizeable down payments and solid sources of income are being turned down because of credit scores, that’s not healthy, either.

Many factors influence credit scores. A temporary spell of unemployment and the resultant hardship can easily push them down. According to a new report from the Pew Research Center, the majority of Americans may find themselves in this situation. Pew separates its respondents into two groups, one that “held its own” — 45%, a number similar to myFico’s estimated 47% of Americans who have the best credit scores (over 720) — during the recession and another that “lost ground” — 55%.

The Pew report’s demographic breakdown may be even more troubling for housing. Those who “held their own” tended to be older people who already owned homes. Real Time Economics recently noted a potential “shadow demand” for housing from people who postponed plans to form new households in the wake of the recession, but that pool of potential homeowners was also more likely to have lost ground during the recession. According to Pew, 69% of people age 18-49 and 60% of those 30-49 lost ground.

It’s likely that those groups, who are the most likely first-time and move-up home buyers, took a hit to their credit scores during the recession. Zillow’s data indicate that even if they’ve recovered from the worst, the may not be able to get a mortgage, and if they do, they also are more likely to face higher interest rates.

Refinancing: Here's What You Need to Know

Refinancing: Whom Can You Trust?

From Conflicts of Interest to Simplistic Formulas, the Web Is Awash With Dubious Mortgage Information. Here's What You Need to Know

By M.P. MCQUEEN

Sept. 18th, 2010

With mortgage rates falling to record lows this summer and the housing market showing signs of a pulse, refinancing activity is perking up.

It's too bad that so many people are relying on oversimplified advice and bad numbers to decide when to pull the trigger.

The refinancing equation has never been more complicated. While some borrowers are desperate to reduce their monthly payments, others are looking to build equity. Some are even treating their mortgage as an investment vehicle, sinking excess cash into their homes in order to secure a lower rate and cut future payments.

Yet most personal-finance resources these days don't account for situations like these. Even essential factors like tax rates and inflation expectations are often ignored in favor of simplistic calculations.

Many popular Web resources, in fact, are financed by lenders, mortgage brokers or "lead generators" that connect borrowers with banks. At times, their advice can be downright harmful.

That's because of the risk involved. Refinancing generally costs 3% to as much as 6% of the outstanding principal of the loan, with banks levying fees on everything from application fees and title searches to appraisal costs and legal expenses.(Mortgage "points" can add to the total, though they typically help reduce the interest rate and lower overall costs.)

Fees are often murky, too, making comparison shopping difficult. The best way to compare deals, says Melinda Opperman of Riverside, Calif.-based Springboard Nonprofit Consumer Credit Management Inc., is to consult with a housing-counseling agency approved by the U.S. Department of Housing and Urban Development.

Given such costs, you don't want to refinance often. Yet the advice coming from the mortgage world suggests you should be doing it regularly.

One particularly dubious idea gaining prominence is the "1% rule," which used to be the 2% rule when rates were higher. The gist: Refinance when you can knock a full percentage point off your rate.

A lead-generation site called Supermortgages.com says the following in a piece called "When to Refinance a Mortgage": "Are the current mortgage interest rates at least 1 point less than your existing mortgage interest? If so, refinancing your home mortgage might make sense."

Wells Fargo & Co.'s website goes further. In an advice article titled "Deciding to Refinance," it writes: "If interest rates are 1/2% to 5/8% lower than your current interest rate, it may be a good time to consider a refinance."

Yet people who followed the one-point rule could have refinanced five or six times in the last 15 years, paying so much in fees that the savings would likely be wiped out.

Supermortgage.com's content largely comes from mortgage brokers, lenders and other industry sources, says Andy Shane, a spokesman for parent company SuperMedia Inc. In this case, he says, the author is a freelance writer with a law degree and a background in real estate who used a mortgage calculator and determined that a one- to two-point cut in rates "made a pretty significant difference in monthly payments" compared with closing costs.

Wells Fargo spokesman Jason Menke says the bank's website has a wide range of information available to help borrowers. "The rate difference cited is just a point where a borrower may want to consider looking into a refinance," he says.

The 1% rule could translate into big business if it catches on. About 71% of outstanding fixed-rate mortgages guaranteed by Fannie Mae or other government-sponsored entities are at least a point above current rates, according to Walter Schmidt, senior vice president at FTN Financial Capital Markets in Chicago.

Bills.com is another lead-generation site that offers personal-finance advice. Its new refinance calculator is among the most basic around: It asks users for some data and their reason for wanting to refinance and then spits out a yes/no answer.

The answer, however, is usually "yes." And sometimes it comes with a suggestion for a risky interest-only loan. It also provides a way for users to sign up for a quote.

Ethan Ewing, president of Bills.com, says the calculator's simplicity and ease are virtues. Most users say they are looking for a fixed-rate loan or a lower monthly payment, he says. "If [users] can save more than $100 a month on the payment with a new mortgage, the calculator says 'yes.' "

Another flawed concept is the standard break-even test. Many mortgage sites suggest that borrowers should calculate how many months it would take to save enough on mortgage interest charges to break even on the closing costs, and then to pull the trigger when the payoff goes below three to five years.

But such analyses often ignore important factors, such as how long the borrower plans to stay in the house or the borrower's tax rate, which determines a loan's after-tax cost.

Consider LendingTree.com, a lead generator, broker and lender. In an article called "When Does It Pay to Refinance a Mortgage?" it warns: "There are other things to consider when you refinance, too, including taxes and private mortgage insurance. For a break-even estimate that takes many of these factors into account, use the LendingTree refinancing calculator."

The problem: The refinance calculator doesn't take taxes into account. It merely calculates your break-even point based on your current payment, the hypothetical new-loan payment, and the closing costs. Right below the results is a button to "start request"—meaning it will start to hook you up with a lender.

"This is a simple calculator that gives you a straightforward break-even equation," says Nicole Hall, a spokeswoman for LendingTree. "You should speak to a loan officer to thoroughly evaluate your options.... Generally, if you can lower your interest rate by 1%, you are saving enough to justify the refinance if you are staying in the home a certain number of years."

Versions of the same calculator appear on the sites of mortgage brokers or lead generators such as Domania.com and Calculators4Mortgages.com.

There are, to be sure, plenty of websites whose advice is unbiased and sound. The Federal Reserve, for example, offers a refinance resource page on its website that includes a better break-even calculator with tax-rate considerations.

A more-sophisticated calculation of the merits of refinancing would include other factors: the borrower's tax rate, inflation expectations, how long the borrower plans to live in the house, the opportunity cost of paying closing costs rather than investing in stocks or bonds, and so on.

One obscure calculator comes close. Instead of plugging in today's mortgage rates and determining how long it would take to pay back the closing costs, it uses "optimization theory" to conjure up a person's ideal refinance rate regardless of where rates are now. If you can find a rate that is equal to that rate or lower, it's time to refinance.

The bad news: Its results tend to flash the green light much less often than other calculators.

The calculator, posted on the National Bureau of Economic Research's website at http://zwicke.nber.org/refinance/index.py, is based on a 2008 paper by two economists at the Federal Reserve and one from Harvard University. Using stochastic calculus, they devised a formula based on the loan size, the homeowner's marginal tax rate, the expected inflation rate over the life of a loan, how long the borrower plans to remain in the house and other factors.

"These ideas are really old hat among economists; our contribution is deriving a simple formula that anyone can plug into their calculator or computer," says Harvard professor David Laibson, one of the authors.

The Optimal Refinance Calculator spits out tougher numbers than many other calculators in part because it factors in the benefit of waiting beyond the break-even for the chance that rates could fall further. Refinance now and you reduce your ability to refinance later.

According to the calculator, a borrower in the 35% tax bracket who has 20 years left on a $400,000 mortgage at 5.88% isn't advised to refinance until rates hit 3.92% (assuming low closing costs of 3%). By contrast, a three-year break-even analysis of those parameters would suggest that today's 4.5% rate is the time to make a deal.

"Some people mistakenly think [the break-even] is a recommendation to refinance," Prof. Laibson says. "You want to wait until things get better than the break-even point. Refinancing is irreversible and really costly."

Another way to benefit from falling rates in the future is via an adjustable-rate mortgage, the norm in places such as the United Kingdom and Australia. People with a strong conviction that deflation will unfold over the next several years can take out an ARM now and refinance later if rates start to head upward, though the transaction costs could add up.

Be warned: The Optimal Refinance Calculator doesn't account for refinancing into shorter-term loans, such as 15- or 20-year mortgages. It also doesn't work for "cash in" refinance deals, which investors increasingly are viewing as investments unto themselves. The bet: With stocks in a 10-year slump and bonds looking bubbly, the best investment they can make is to cut their future mortgage payments.

A new cash-in mortgage refinance tool, launched on Aug. 25 at www.mtgprofessor.com, calculates the "internal rate of return" on the cash a borrower puts into an underwater home loan to pay off the balance and cover closing costs. The money saved each month and the balance reduction is treated as a return on the cash invested. Compare that with your expected returns on stocks or bonds to see if a refinance makes sense.

Jon Krieger, 34 years old, and wife April, 32, of Blairsville, Ga., didn't need to invest extra cash—they simply wanted to cut their mortgage payment. Mr. Krieger says he tried several times last year to refinance but couldn't because bank lending standards were too tight.

It's a good thing they didn't refinance last year. Rates have since fallen even lower—precisely the possibility the Optimal Refinance Calculator considers.

In August the couple refinanced their $416,000, 6.75% loan they took out in May 2007 with a new loan at 4.75%. It lowered their monthly payment by more than $500. The total closing costs were about $5,500, says Mr. Krieger.

The deal easily satisfies the 1% rule and the three-year break-even. It also survives the Optimal Refinance Calculator, which put the Kriegers' ideal rate at 5.63% or below.

"We just kept plugging away and finally this came along, and it worked out real well," says Mr. Krieger. "I was very pleased."

Write to M.P. McQueen at mp.mcqueen@wsj.com