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Refinancing Blues
In the minds of all borrowers and many lenders, refinancing is a simple, straightforward concept. Sometimes, overconfidence leads to surprises.
Other than having your file misplaced for a few months, unhappy refinancing outcomes can be traced to just a couple of sensitive spots on the underwriting corpus: the borrower desire to convert home equity into cash, and the issue of primary residences versus all others.
While frustrated needs for cash merely annoy everyone involved, the primary residence argument can produce at least one kind of spectacular disaster.
If you want to turn some of your equity into cash, the new loan is known generically as a "cash out" refinance, as distinct from a "rate/term" rearrangement of the existing loan amount (extending or shortening term, ARM to fixed, combining first and second, but no new cash).
Applicants for cash out loans often feel as though they are being accused of some form of attempted theft, and suffer through a bright bulb interrogation. (Customers are not alone: underwriters treat local lenders as though they were accomplices in this larceny.)
Cash out loans are treated this way because it is nearly impossible for underwriters to sort straight deals from scams, So, in the hyper-suspicious world of underwriting, everyone is presumed to have a scam underway.
The first serious experience with cash out defaults came in the Texas and New England meltdowns, where extraordinary gains in value were followed by regional recessions, job losses, and rapid unraveling of values.
Underwriters can't detect the borrower whose last financial transaction prior to bankruptcy will be to turn home equity into cash in an effort to defend an untenable position.
A person facing job loss won't go out to buy a new house, but might well try to get access to home equity in a falling real estate market. Hence, lenders will make purchase money mortgages up to 95% of value, but will rarely loan beyond 75% of value on a cash out basis.
This principle is not hard to understand, but in practice the theory leads to a succession of invisible Catch 22's.
Some of the catches open and shut quickly -- just a brief instant of pain, and you are turned down. For example, don't bother to try to pull cash out of a rental propeerty (except on an accommodation loan of some kind, or an ARM with quite inferior terms). Fixed rate cash out on a rental has been impossible since 1987.
The exquisite catches are the ones that let you wriggle around for a while.
Let's say you amble in to Mortgage World to get a nice, low rate on your old mortgage and want to include the second mortgage you took out in December to pay four years' tuition for junior. You've got a good steady job, the first mortgage is only $90,000, the second another $36,000, and the house is worth a cool hundred and fifty grand. No problem with this loan, right?
Ahem. See, that second has been around for only six months. If you pulled out home equity in a second mortgage in the last year, it's the same as cash out today (!). A total new loan of $126,000 is 84% of the market value, over the 75% rule, so we can't help you.
Okay, you say, let's just redo the first -- it's at a 10% rate. So sorry. Your second rolls annually (like most equity lines of credit), and besides, the second lendder won't subordinate to a new first.
See you in December. Of course, by then we'll have to do another appraisal, and there is no telling where rates will be.
It's amazing that chats like this don't more often end in fist fights.
Another common catch is very common in Boulder these days. Let's say you bought two years ago for $200,000, and your mortgage was $150,000. Now the place is worth $300,000, and you would like to reduce the rate on the first, and borrow another $50,000 forwhatever. No sweat, right? A 66% loan should be easy.
Ain't necessarily so. All lenders reserve the right to turtle up in the presence of rapid appreciation. They will give you heartfelt congratulations, but decline to turn your good fortune into cash until a reasonable time has passed. How long in "reasonable"? Each underwriter will have a different answer.
Then there is that business about primary residence.
Lenders take a less creative view than, say, George Bush, whose primary residence for fifteen years has been a hotel room in Houston.
The worst possible refinance disaster goes like this (and it's happening in Boulder about once a month.)
Your current home has a mortgage with a 10% rate. You plan to buy a new house, but you want to refinance to a lower interest rate because you are going to hang on to the house you have as a rental.
You go over to House of Mortgage, and apply for a refinance. They ask if this is your primary residence, and you say sure.
Two weeks later, you notice the police K-9 unit trying to keep a crowd under control while a Realtor puts up a sign in front of a new listing. It is exactly the house you hoped to find. While a German shepherd grins at you, hopefully, you hear that your offer won the bidding contest.
Next day, MegaMortgage has the best rate, and you go in to apply for a loan on the house you just put under contract.
Three weeks later, you close your refinance.
Two weeks after that, the manager of MegaMortgage calls to say that your purchase loan was submitted to the same wholesaler which made your refinance loan.
Two days later, a certified letter arrives from your refinance lender asking you to send all the money back -- the whole loan -- NOW, please.
Though you are still living in your house, if you have the intent to leave it, it is no longer your primary residence. Loans on non-primary residences are called non-owner occupied.
Non-owner default rates are maybe a hundred times higher than owner-occupied ones, and your newly closed refinance loan cannot be sold as closed. The lender would rather foreclose than hold an unsalable loan.
It usually turns out okay, after your attorney contacts House of Mortgage, and you convert your refinance to an expensive, non-owner occupied one. Of course, the house you wanted is history.
If you are contemplating a refinance involving cash out, or a move, or even own more than one property, ask lots of questions. And hope the lender gets out the unshaded bulb at the very beginning.
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