About Government Refinance and Home Purchase Programs

As it turns out, most refinances of loans below $100,000 don’t make a lot of sense in the end. Here is why: There are fixed costs associated with a refinance and those fixed costs are the same for a small loan as they are for a big loan. See this page for more on the costs associated with refinances.

So for example, let’s consider a loan of $100,000 at a 6.75% interest rate. The borrower hears that rates have dropped to the low 5’s and assumes that a refinance is a no-brainer. But let’s take a look at the numbers. Here are the fixed costs:

Bank fees and appraisal — ~$1400 (assuming no points)
Title and escrow fees — ~1000 (depends on the state)
FHA upfront insurance fee — $1750 (1.75%)
Tax and insurance prepayments — ~$1200 (This is not actually a fee, but it does roll into the loan anyway)

So in this scenario the borrower ends up with a new loan of $105,350. Now some of that is offset because the borrower skips a month of mortgage payment and the old escrow account (assuming one is in place) is refunded, but even so the actual costs are probably around $4000. None of that is out of pocket but the costs are still real.

Now here is the problem. Even if the new rate is at 5.0% the payments on the FHA loan would probably only be about $40 less per month when we factor in the FHA monthly mortgage insurance. That means the borrower will save about $500 per year. And that means that it would be at least 8 years before that borrower broke even on the costs associated with the refinance. Of course if the borrower plans to never sell the house such a refinance makes a lot of sense because $500 per year is very helpful. But if the borrower might sell the house in a few years the refinance makes less sense.

So the takeaway is that for smaller loan to make sense normally one or more of the following must be true:

1. The current interest rate is very high (at least mid 7s or higher)
2. The borrower does not plan to sell the house for several years
3. The borrower needs cash out to pay down other high interest rate debts

For instance, if the original loan in our scenario above were at 8% (instead of 6.75%) then the savings on the refinance would be more than $120 per month. With those kinds of savings the refinance starts to make a lot more sense.

The good news is that for larger loans the fixed costs are much less of an issue and the numbers usually work out quite well.

Please contact us if you have any questions about this subject.

As we have noted here in the past, with the failure of the Hope For Homeowners program in the Fall of ’08 there haven’t been any reliable refinance options for people who have conventional mortgages and owe more than their home is currently worth. For the last few months we have suggested people contact their lender about a loan modification.

However, there is one possible solution that we have only recently started looking at again. According to the FHA regulations, as long as the FHA loan is in first lien position and does not exceed 97% of the current value of the home FHA does not care if there is a second mortgage behind it. Here is an example:

1st mortgage = $185k conventional loan at 7% (no late payments)
2nd mortgage = $65k ARM loan at 9% (no late payments)
Current appraised value of home = $200k

In this example the homeowners are in some trouble. They owe $50k more than the house is worth. But here is where FHA can step in. Assuming these homeowners meet FHA income and credit requirements, they could refinance out of that 7% first mortgage and get an FHA loan at a much lower rate (based on rates this week at least).

The Catch

But here is the catch: When a first lien/mortgage pays off the second mortgage automatically moves into first lien position and FHA insists on being in first lien position.

The Solution

The solution to this problem is to convince the second mortgage holder to stay in second lien position for the refinance. This is called subordinating the loan.

For much of 2008 it was difficult to convince second mortgage holders to subordinate their loans. But as the economy has continued to weaken more and more second mortgage holders are willing to consider it now. The logic is pretty simple: If the family in our scenario above foreclosed and after all the costs the home sold and cleared $180k for the banks, that entire amount would go to pay off the first mortgage and the second mortgage holder would get nothing. So it is very much in the interests of second mortgage holders to agree to subordinate their loan if it decreases the chances of a foreclosure.

If you are in a situation where this FHA feature could apply and be useful to you, please contact us in the sidebar and explain your situation in the notes section.

Paul Jackson over at Housing Wire put up an interesting article on the state of refinancing in the US. The upshot is that a lot more people are applying for refinances than the number of people who are actually obtaining refinance loans.

With rates quite low these days a lot of people are seeking to refinance. But with housing values dropping quickly, credit score requirements increasing, debt to income ratio requirements tightening, and job losses mounting recent numbers shat that fewer than 50% of refinance applications are funding.

In many cases government-backed loans give borrowers the best chance of getting approved for a loan. Contact us in the sidebar if you are interested in refinancing while rates remain low.

In what appears to be a growing trend, JP Morgan Chase (including its subsidiaries WAMU and EMC) recently announced it is expanding its loan modification program. In a recent press release the company said the following:

Chase announced today that it has extended its mortgage modification efforts to the investor-owned loans that it services — about $1.1 trillion of loans — significantly expanding the reach and effectiveness of its previously announced mortgage modification efforts. This effort includes investor-owned mortgages held in securitizations.

“When homes are foreclosed, everybody suffers, so working aggressively to modify all loans -whether owned by Chase or owned by others – on terms that should work for the borrower, makes good sense for everyone,” he said. “Our experience at Chase has shown that when mortgages are properly modified, using income verification and other appropriate criteria, they perform very well over time.”

This is welcome news for struggling homeowners who are delinquent on their mortgages. While the government programs are a great fit for homeowners who have not fallen behind on mortgage payments, loan modifications are currently the only solution for people who are more than 30 days delinquent.

As we have noted, the original Hope For Homeowners program signed in to law last summer proved to be a spectacular failure. The question now is if the program will just fade away or if the incoming chief of HUD in the Obama administration, Shaun Donovan, will try to revive it. Here is a quote from him in a recent Reuters news piece:

HUD has been roundly criticized for its implementation of a mortgage refinance program called Hope for Homeowners that was conceived this summer to rescue 400,000 troubled borrowers but has retooled fewer than a thousand loans.

“I think it’s clear to everyone that there needs to be some changes to make sure that program is effective,” Donovan said.

Doesn’t sound like a commitment one way or the other to me. We shall see I suppose.

The Fed is making good on its promise to purchase mortgage backed securities. According to this article more than $10 billion in such securities were purchased in the first week of January. The program is having the desired effect as well — mortgage rates remain very low. All good news to folks looking to purchase a home or refinance into a better rate.

Here is an excerpt from the article:

The Federal Reserve Bank of New York said it bought $10.2 billion in mortgage-backed securities this week as it launched a program to lower home borrowing costs.

The purchases are part of a $500 billion program announced by the central bank in November as a way to help stabilize the U.S. housing market, which has entered its third year of a downturn. The MBS — issued by Fannie Mae, Freddie Mac and Ginnie Mae — have rallied since the Fed announcement, sending yields that influence consumer rates sharply lower.

The average fixed 30-year mortgage rate dropped for a 10th consecutive week as of Thursday, to 5.01 percent, the lowest since at least 1971, according to a Freddie Mac survey.

Several months ago a homeowner in Southern California contacted us for some guidance. Her family was deeply upside down on their home, with the first and second mortgage adding up to more than $100,000 greater than the current value of the property. Initially we were hoping that the Hope For Homeowners programs would be a success and help the family out. But this fall it was becoming apparent that H4H was a flop so we recommended she proceed with trying to get a loan modification with her current lender.

Well things apparently worked out. We learned a few days ago that her current lender offered her a 5 year interest only loan at less than 4%. That significantly reduces the family’s payments for the next five years and keeps them in the home.

Why would a bank offer such a program? Well in this situation it makes good business sense. The bank knows that if they did nothing the family might be forced to simply not pay at all. That would likely lead to a a foreclosure in 6-12 months. Foreclosures cost banks a lot of money in legal and administrative fees to begin with, and in this case the bank would only net a home that is worth $100,000+ less than they lent to begin with. Plus the bank runs the risk of vandalism and all sorts of other bad things if it tried to foreclose.

So the bank apparently decided it would better to keep the family in the home even at a very low interest rate. It is true that the family might not be able to make the pending higher payments in five years as well, but in that time the values of homes in the area could be back up again so foreclosing would make more sense if it came to that.

The good news is that banks seem to be coming around and seeing the light when it comes to loan modifications. The moral of the story is that if you are upside down on your home and can’t keep up with payments, and you don’t currently have an FHA or VA loan, your best option is to contact your current lender about a loan modification. (If you are upside down and have an FHA or VA loan now contact us about a streamline refi). With any luck stories like this one will soon be commonplace because as the housing market heals the US economy will follow.