Wednesday, February 06, 2008

No to refinancing option

Last week I received a number of calls from past clients asking me about refinancing their existing home loans. I told each one the same. No, I wish I could help but the recent changes in loan underwriting guidelines and the decrease in your home’s value will not allow you to take advantage of the lower interest rates.

As I have written before in this column, the Federal Reserve Discount rate does not directly apply to residential mortgages. Unless you are a federally chartered bank or S&L the Federal Funds rate will not affect you immediately. The interest rates on 30-year home mortgages actually increased after the Feds lowered their rate. The rate that the Federal Reserve charges member banks will have an affect on home equity lines of credit and maybe long-term mortgages in the future but not immediately and not directly.

Here are three examples why I am saying no to clients who want to refinance.

I helped Gary purchased a home in Roseville several years ago for under $200,000. Three years ago Gary decided he needed a larger home but he decided to remodel and add a room addition rather than buy a different one. To finance the remodel and room addition, Gary took out a $125,000 home equity line of credit. Now, he was interested in paying off the line of credit with a total refinance of both mortgages. This would convert the adjustable interest rate home equity loan to an amortized fixed rate and he could take advantage of the 5.5 long-term interest rates.

A refinance didn’t work for Gary. Here’s why. Lenders treat paying off a Home Equity Line of Credit as a “cash out refinance.” Refinancing to obtain a lower mortgage rate “Rate & Term” is considered a prudent financial move and lenders offer their lowest interest rates. But refinancing to pay off consumer debt or when converting a home’s equity to cash for other uses, is considered a “cash out” refinance and lenders charge higher interest rates and demand a borrower have a higher equity in their property.

A year ago “cash out” refis were common regardless of a homeowners equity position. Today, lenders require a borrower have a 25 percent equity position in their home. With Gary’s $125,000 home equity loan he did not have sufficient equity to warrant a refinance even at a higher interest rate.

Joan called about refinancing. She had purchased her home in 2005 with a 5 percent down payment. Her low adjustable rate was still fixed for another two years but she wanted to convert the entire loan to a fixed-rate now before the interest rate increased in another two years. I did a search of recent neighborhood sales and informed Joan that her house was worth about what she had paid for it back in 2005. Since she did not have sufficient equity, she could not refinance.

Bill is an investor that I had helped find a rental in early 2006. At the time and against my advice, Bill wanted a 90 percent adjustable rate loan with an interest start rate of 1 percent. This would allow him to have initially low payments for a year or two until he sold the house at a profit. After Bill purchased the property he took out a home equity loan in order to pay off some credit card debt. Now that Bill’s adjustable rate had ratcheted up he was desperate to refinance to a lower rate. I don’t usually remind my clients about not heading my advice but could not resist the urge to remind Bill that we had discussed the potential for this situation when he was considering a mortgage. Few lenders like financing an investment that has a negative cash flow.

There are a number of variables with every loan. Property values and owner’s equity is prohibiting most refinancing. This is a short-term situation. Hopefully, borrowers who extracted cash from their home’s equity loan spent the money wisely. They may be paying the bill for a long time.


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