Mortgage refinancing tips for 2009 (1/2/2009)

When the Federal Reserve Bank lowered the Fed Funds rate on December 16, it caused the mortgage rates in the U.S. to drop to levels we saw during the housing boom of 2002-2006. In January of 2008, the typical 30-year fixed rate mortgage was approximately 6.125%. Today, the rate for that same loan is now 5.125%. For a typical $200,000, that a monthly savings of over $150 per month.

As you can imagine, this has caused a spike in applications for mortgage refinancing. Therefore, I thought this would be a good time to let you know how the downturn in the economy has changed the credit market. The “credit crunch” has created additional obstacles in the loan underwriting process that weren’t previously there. Here are some things to look out for if you plan to refinance your mortgage in 2009.

1. Credit based pricing. This is a practice that was typically reserved for car loans only. This is when a lender will offer you a higher rate if your credit score falls below a specified threshold. Now, most lenders are practicing credit based pricing on mortgage loans. For example, if your credit score is between 700-725, they will add .25% to your rate. If it falls between 675-699, they will add .50% to your rate. And so on. This is just an example and every lender’s tiered pricing is different. In addition to credit based pricing, the minimum credit score for approval is also higher. In other words, no more subprime loans. If you’re not sure what your credit score is, go to www.annualcreditreport.com to get a copy of your credit report and your credit score prior to applying for a loan.

2. Loan-to-value pricing. This is the practice of adding “rate adjusters” to the mortgage rate if the loan-to-value is higher than 80%. If the mortgage you’re obtaining is higher than 80% of the value of your home, it’s considered a high risk loan to the bank. So, to compensate for the higher risk, they will offer a higher rate. See example in #3 below.

3. Declining property values. As we all know, property values have dropped over the last 18 months. If you purchased a home in the last five years and put down 20%, refinancing isn’t a slam dunk. The value of your home may have declined to the point where you now have less than the original 20% worth of equity in your home. This could happen despite the fact that you’ve been paying down your mortgage. Now, your loan-to-value is higher than 80% and this may cause the lender to add rate adjusters. Here’s an example: In July 2006, Bob purchased a home for $250,000 and put down $50,000 (20%) and borrowed $200,000 (80%). Today, Bob wants to refinance, but the value of his home has fallen to $230,000 and his mortgage balance would be $193,000. His loan-to-value went from 80% at the time he purchased the home to 84% now. Because the loan-to-value is greater than 80%, the lender may add a rate adjuster. So instead of getting a rate of 5%, he may be offered a rate of 5.25%. In addition to getting hit with a higher rate, Bob will be required to pay Private Mortgage Insurance (PMI) since the loan-to-value is greater than 80%. PMI is typically ½% per year, so his mortgage payment would be increased by $80 per month.

4. 100% financing. No matter how great your credit score may be or how stable your financial situation is, the odds of you obtaining 100% financing is almost non-existent today. The handful of banks that will offer this are charging a premium rate for the additional risk. This includes the popular 80/20 deals as well. While the 80% mortgage will avoid PMI costs, the 20% 2nd mortgage will be met with some tight restrictions that weren’t in place previously, such as property requirements, rate adjusters, and credit score minimums. 100% financing is still available, just not as easily or abundantly.

5. Floors. I’ll try not to get too technical on this item. As you may have heard, the Prime Rate fell to 3.25% on December 17. In December 2007, the Prime Rate was 7.25%. If you plan to get a home equity line tied to the Prime Rate, expect to have a “floor” for this loan. A floor is the lowest the rate will go no matter how low the index goes. For example, if the rate offered for your home equity line is Prime + 1%, your rate would be 4.25% today. However, if a floor of 5% existed, your rate would never go below 5%. Technical part: The cost of credit to a bank does not always reflect the competitive environment, therefore, the bank has to set a floor in order to guarantee a margin of return for the loan. Without a floor, indices could drop a rate below the cost of funds creating a loss for the bank. There are also floors on credit cards as well.

If you plan to refinance in 2009, just be aware that you’re up against more obstacles than you were in the past. Be sure to do your home work. As always, feel free to e-mail or call me with any specific questions.