Tuesday, May 09, 2006

Larger loans with higher rates

Huge numbers of loans are being refinanced with larger mortgages. In the first quarter of 2006, Freddie Mac says that 88 percent of its loans that were refinanced were replaced with loans that were at least 5 percent larger. This is the highest rate of equity withdrawal in the past 15 years.
There is a mystery here: In a mortgage environment with rising rates why would borrowers want to refinance?
Since the summer of 2003 mortgage rates have climbed from roughly 5.2 percent to 6.6 percent. If you borrowed $300,000 at 5.2 percent your monthly cost for principal and interest would be $1,647 over 30 years. At 6.6 percent, the monthly cost would be $1,916.
For recent fixed-rate borrowers refinancing to just get a higher monthly cost makes no sense. There has to be something else at work here -- and there is. It is those without fixed-rates who are refinancing in big numbers.
The Federal Reserve says that "roughly 85 percent of first mortgages were fixed-rate in 2001, slightly more than 10 percent were adjustable-rate, and the rest were balloon." But now the numbers are different. Figures from the Mortgage Bankers Association show that in the first six months of 2005 -- the latest available figures -- only 40 percent of all loans by dollar volume were fixed-rate products.
In other words, 60 percent of all recent loans by dollar volume are adjustable or interest-only. More upsetting -- and more financially dangerous -- large numbers of these loans are high-risk, little down, high-balance products that feature or allow low monthly payments for the first several years of the loan term, payments that will surely increase after three, five or seven years.
This means if you were sucked into a loan with low up-front payments you knew there would come a time when monthly costs would rise even if mortgage rates remained steady.
Many borrowers, seeing what looms ahead, are refinancing. If they refinance with a fixed-rate loan they likely see higher-but-tolerable monthly payments today but they get the benefit of steady and known future payments. If they refinance with still-another high-risk toxic loan, they postpone, delay and defer that ultimate day of reckoning.


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