Monday, March 16, 2009

Many borrowers pay a premium to refinance

It is unusual to have a refinance boom in the middle of a foreclosure crisis. In the 1930s, which was the last time we had a foreclosure crisis comparable in magnitude to this one, lenders were so spooked by the foreclosures that there was almost no refinancing. That changed only after the creation of the Home Owners Loan Corp. in 1933, which refinanced many borrowers at the government's risk.

The refinance boom today is also fueled by government. With few exceptions, refinanced loans are either being sold to Fannie Mae or Freddie Mac, or insured by FHA. The requirements of those agencies largely dictate who can and cannot profit from a refinance.

The refinance decision involves a comparison of what a borrower has with what he can get. If he is paying 5 percent and can refinance at 4.5 percent and no fees, he will profit from the refinance. If he is paying 7 percent but the best he can get in the current market is 7.5 percent, he can't.

Borrowers with fixed-rate mortgages usually know what they have, but borrowers with adjustable-rate mortgages, or ARMs, often don't. I have received letters from borrowers in a state of high anxiety because their ARM faced a rate reset and they felt they had to refinance before that happened. In some cases, a close look revealed that their rate was probably going to drop sharply, making it unnecessary to refinance quickly - if ever.

Readers who ask me whether they should refinance usually tell me what they have but seldom tell me what they can get. They expect me to know that, but I don't because it depends on so many factors specific to them that they haven't told me about.

Borrowers in the best position to refinance profitably have loan balances of $417,000 or less secured by a single-family house in which they reside, have a credit score of 800 or more, and have equity in their property of 20 percent or more. The interest-rate premiums associated with deviations from this standard are larger today than I have ever seen them. Note: The premiums reported below are those being quoted by large wholesale lenders on 30-year fixed-rate mortgages, and are reflected in the retail rates quoted by mortgage brokers and many if not most lenders. They may not apply to smaller credit unions or community banks.

Loan size: Borrowers with loan balances above $417,000 up to $625,500, who live in higher-cost areas where Fannie and Freddie are authorized to buy loans up to $625,500, will pay a rate premium of about 1 percent. These are "conforming jumbo," meaning they can be purchased by the agencies but are priced higher than non-jumbo loans.

Borrowers with balances in excess of $417,000 who do not live in a high-cost area, or who have balances in excess of $625,500, will pay a premium closer to 2 percent. These are "nonconforming jumbos" that cannot be purchased by the agencies.

  • Type of property: On loans secured by condominiums, figure on paying a rate premium of 0.75 percent, and on 2- to 4-family homes the premium can be twice that large.
  • Loan purpose: If a loan is secured by an investment property, figure on paying a rate premium of about 1.375 percent. Those refinancing who borrow more than their loan balance will pay a premium of about 0.25 percent. However, they can finance settlement costs without it being considered "cash-out."
  • Credit score: Shortfalls from excellent credit, defined as a FICO score of 800, have become very expensive. Even a score of 780 can cost a rate premium of 0.125 percent. The premium on a score of 700 is about 1.125 percent, and on a score of 600 it can be a prohibitive 2.625 percent.
  • Equity: If a borrower has equity of less than 20 percent - meaning that the loan balance exceeds 80 percent of current property value - he will pay a mortgage insurance premium. This can make refinance a loser for borrowers whose recently purchased homes have declined in value. For example, if Jones borrowed $160,000 to purchase a home for $200,000 in 2005, still owes $158,000 and the house is now worth only $180,000, a refinance will require mortgage insurance where the original loan did not. If the house is worth only $150,000, the loan can't be refinanced at any price.
  • Approval: On loans that will be sold to Fannie and Freddie, increased risk premiums have been accompanied by tougher approval standards. In particular, documentation of income, which had grown lax and sloppy during the go-go years, is now rigorously enforced. Approval is also dependent on a satisfactory combination of all the risk factors discussed above. For example, a FICO of 650 might be approvable if all other factors are favorable, but a 650 score on an investment property with only 5 percent equity will be rejected.

Loans that won't be approved by the agencies might past muster with FHA, whose requirements are more liberal, but FHA loans carry higher rates and insurance premiums. I will have an article on who should take an FHA in the near future.


Friday, March 13, 2009

Duncan Grilled About Obama’s Student Loan Proposals

Education Secretary Arne Duncan ran into some pointed questions on Capitol Hill Thursday about much of President Obama’s higher education agenda.

Obama’s budget blueprint proposes eliminating subsidies to private lenders who make federally guaranteed student loans. Instead, the government would make such loans directly, with banks and other financial companies merely servicing the loans.

Both Democrats and Republicans on the House Budget Committee questioned whether the Education Department has the capacity to originate all federally backed student loans. Ranking Republican Paul D. Ryan of Wisconsin denounced what he called a “government takeover” of the lending system. Under the president’s proposal, the government would stop providing subsidies to private lenders in mid-2010.

Thomas P. Skelly, director of the Education Department’s budget service, said the department could handle a significant increase in the direct lending program, in part because it still would use private lenders to service those loans.

“The main difference is with direct, the interest borrowers repay comes back to the government,” he said. Under the subsidized private system, “interest stays with the banks. The programs are really very similar.”

Ryan and other Republicans also objected to Obama’s proposal to transform Pell grants for low-income college students into an entitlement, so the funding would not fluctuate according to the annual congressional appropriations process.

Ryan objected to Obama’s plans to make Pell grants another “autopilot entitlement immune from congressional oversight.”

The president proposes increasing the maximum Pell grant to $5,550, indexing the grant to account for inflation and making the spending mandatory, not discretionary — all at a cost of $116.8 billion over the next 10 years.

Duncan said that increases in Pell grant maximums, combined with other higher education initiatives in the budget and the economic stimulus package, would amount to the “biggest boost in higher education funding since the GI bill.”