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Posts Tagged ‘risk-based lending’

Mortgage interest rates continue to be at historic lows.  Rates for 30-year fixed rate loans are hovering in the 4% to 4.2% range. There’s no real whiff of inflation in the air that could lead to a spike in interest rates any time soon.

So should you refinance?  Crunching the numbers is crucial.

When I was a mortgage banker, the rule of thumb would be it made sense when prevailing interest rates were 2% or more below your current rate.  With the availability of zero point and zero closing cost loans, it even made sense when the rate was a mere 1/2% difference.  It was common for homeowners to get calls from their mortgage brokers alerting them that the rates had dipped and they should refinance even before the homeowner may have made their first mortgage payment on their new loan.  It was even common for mortgage brokers to keep current copies of income, credit and asset verification forms on file in order to start a new application quickly.

Things have certainly changed since the refinance booms of the 1980s and late 1990s.

Property market values have fallen throughout many parts of the country.  The number of jobless are at historic highs.  Credit has been strained by more than two years of economic crisis and now malaise. Banks are in much less tolerant moods now to offer special deals or bend the rules when underwriting a loan.

Since buying and owning a home is one of the largest investments for many, it pays to consult with a professional who can help you sort all of this out.

Break Even

One of the first things that an adviser can help you do is make an informed decision about how this refinance will impact the total picture for your personal finances.

Paying off debts and consolidating credit cards may look good but if you’ll just end up running up the tabs on these accounts right after the refinance, then you’re no further ahead.

Assuming you will not be tempted into debt again, then you need to figure out what the refinance will cost compared to the potential interest savings.  The “break even” point in terms of months or years is calculated by dividing the costs by the projected savings.

For example, if you took out a $400,000 loan three years at a 30-year fixed rate of 5.5%, then your principal and interest payment(P&I) is $2,271.16 per month.  After three years of payments, your balance is about $382,905 if you made no additional payments to principal.

Let’s assume that the prevailing rate now for the same loan term is 4.5% and your new loan will be just enough to pay off the old balance and any closing costs for this loan.  Assuming a new loan amount of $395,000 to cover 1 point (or 1% of the loan), plus the various fees and the payoff balance of about $385,200 (payoff balances are higher than statement balances because of accrued interest), then the new monthly payment is estimated at $2,001.41 for P&I.

The $9,800 in closing costs divided by the estimated monthly savings of $269.75 translates to a break even of 36 months. So if you think you’ll likely remain in the home for at least 3 years, then it may mean more cash flow into your pocket.

Selling or refinancing before then means that you will not be better off and your actual effective interest cost for borrowing (the Annual Percentage Rate) will actually be much higher than the stated coupon rate.

What’s not taken into account by this calculation is the additional interest that you are going to pay because you will be extending the term of the loan by three years. Sure, the new loan will be written for a 30-year term.  But so was the last one you had started three years ago in this example.  So instead of being mortgage-free in 2037, you’ll be paying on this loan until 2040 if you don’t refinance before then or sell the property.

Try a Different Term

Just because you’ve always had a 30-year fixed rate doesn’t mean that you have to always get the same term.  Usually, a term of 20-year or 25-years is offered at the same interest rate.  Assuming you can handle the higher payment for the shorter term, it may make sense.

In this example, a 25-year term fixed rate loan at 4.5% for $395,000 will mean a P&I payment of $2,195.54 each month.  Compared to the original loan payment of $2,271.16, this means your monthly cash outflow will increase by $75.  But you will save two years in interest payments over the old loan.

Cash In or Cash Out

Instead of “cashing out” equity and walking away from the closing table with a check, it’s becoming common to see people “cashing in” and come to the closing table with a check to pay towards the loan payoff.

This may be because the homeowner wants a lower payment.  Or it could more likely be because of the drop in property value and the lender’s loan-to-value limits.

In either case, you now need to consider whether locking up this cash by paying it to the bank makes sense. Will it still leave you with sufficient emergency cash reserves? Besides flexibility, what else are you giving up?  Could this money be invested somewhere else and what could you expect as a return?

This is the kind of comparative analysis that a qualified financial adviser can provide when making such financial decisions.

Home Equity Value: Another Potential Problem

These are best case scenarios.  What happens if the property value has dropped?  If you had less than 20% equity in your property when you bought or last refinanced, it’s quite possible that you may not have enough equity to do a refinance.  Or you might be underwater with your current loan above the market value.

Even if there is equity to do a refinance, there are new risk-based lending guidelines that require the lender to tack on an additional amount to the interest rate or the closing costs or both if the loan amount is higher than 75% of the appraised value.

And depending on the area, some lenders are not taking the appraised value provided by the appraiser without reducing it by a 5% “haircut” which may make it economically unfeasible to do the loan or qualify under the lender’s counter-terms offered.

Staff Crunch, Delays and Legal Issues

Given the low rates, lenders are swamped with applications and may not be able to process an application within your rate lock period.

And recent issues regarding the proper filing of mortgage documents that is now resulting in some homeowners challenging their foreclosures could spill over to good credit quality borrowers as well.  In addition to the drain on lender resources to fix this problem, it could delay conveyance attorneys or title companies in tracking down the records needed to do a proper title search.

So should you refinance? If it fits into your financial plan, then yes.  If you don’t have a financial plan, then call a qualified adviser to get one before trying to figure all this out on your own.


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