Cash out refinancing, where you borrow above what you owe on your existing mortgage, is many times a better way to go than getting an equity line. Equity lines are usually adjustable rate mortgages based on Prime Rate, which is currently very low. But:

-Prime Rate can spike with a lot of volatility.
-Prime Rate equity lines are “interest only”, so you are not paying down the principal. You may as well put your new kitchen or bathroom on a credit card, and never pay it off.

So if I can, I prefer to counsel people to do a cash out refinance of their entire mortgage.

However, the problem is that loan-to-value’s have gotten stricter (i.e. lower), so a cash out refinance has gotten harder to get these days with appraisals seemingly flat to dropping (depending on the area). The current loan-to-values (LTV) are:

-Conforming Loans, which go up to $417,000, you can still go to 80% LTV, but will get a little better rate at 75% LTV and lower.

-Conforming-Jumbo loans, which go from $417,001 to $729,750 (in high cost areas) are limited to 60% LTV. This new category of loan was created by Congress to stimulate the purchase of homes, so the cashing out of homes has a very restrictive (i.e. low) LTV.

-Jumbo loans, over $729,750, are usually limited to 75%, or less.

-And on FHA loans you can borrow up to 85% LTV.

-And to compare, most equity lines cap out at 80% LTV.

Here is an examples:

Your house is worth $500,000 and you owe $300,000 on the current mortgage. On a new cash out refinance mortgage you can get up to 80% LTV since this would be a Conforming loan, or up to a $400,000 new loan amount, which yields you $100,000 cash out (less after you subtract closing costs). Or, you can leave the existing $300,000 loan in tact, and you can get a $100,000 equity line.

So you can see how you really need a lot of equity before you can pull some equity out in a cash out refinance.

I always felt like an “Interest Only” loan (where you pay no principal and are only making the interest payments on the loan) was like taking your house and putting it on a credit card. I was never a big fan of these loans, and as a result never did many because clients always sensed my unease, and ended up going to the competition who talked these loans up as a great way to “get in the market.”

I thought the Interest Only loan has been put to bed, and no one was doing them anymore. I did not think any client wanted them, nor did I think many banks offered them. But, I was surprised when an old client of mine said he was approached by a lender to refinance from his fixed rate mortgage to an Interest Only loan. Huh? Why take a loan (which was already at a decent rate, by the way) where you were paying the debt down, and put it on a credit card?! I was astonished. Here was the exchange:

“Brian, I’m at 5% on a 30 Year Fixed on about a $335K balance that you got me. House worth about $450K now per Zillow. Going to retire and move out in about 5 years. Another broker called to offer me an interest-only 7-year adjustable Interest Only at 4.5% or 10-year adj. IO at 4.75%, with about $5500 closing costs, including new escrows. What do you think about a 7 or 10-y adjustable
interest-only. I didn’t want to go any further without checking in with you for an honest opinion and a shot at a deal if it’s a good idea. I have a hunch that if it were a good idea you would have mentioned it already; so I’m suspicious of the offer from the other broker.”

My reply:

“Wow, I did not know lenders are that hard up out there. That is a guy who is on a fishing expedition, that is all. And shame on him. He is probably one of those “list buyers” and your name is on a list of people that have between 5% and 6% mortgages. And they use different strategies at different rate levels to try and convince people to refi. At 5%, they know your rate is not that bad, so they trot out ARM’s and Interest Only loans.

There are brokers out there who are trying to create deals out of thin air, by convincing people (and sometimes it is an easy pitch in this very tough economy) to refi off of their fixed rate loans to an Interest Only loan. The lower payment sounds great, but why would you put your house on a credit card, which is effectively what you are doing with an Interest Only. You are only reducing your payment by stopping the payment of principal.

And taking a regular, amortized ARM may make sense, if there was enough savings, but there is not. I would have already crunched those #’s. If you are at a 5% Fixed Rate now, and he is offering you an ARM at 4.75%, there are no savings in interest. If the monthly payment is going down that is only because you are starting the clock over again on a new 30 year loan, and using the lower balance that you have paid down to, as the new starting point. That is called robbing Peter to pay Paul.

If you want to take a risk, and gamble that you’ll be gone in 5 years, I’d do a regular amortizing 5 Year ARM. I have a regular 5 year ARM at 3.875% with 0 points. So you’d have 3.875% for 5 years, and then a possible adjustment. Going from 5% to 3.875% would save “real” money, however there would still be some “robbing Peter to pay Paul affect”. But, if you really want to save cash flow, its a thought. But don’t do an Interest Only loan, if anything, consider an amortizing 5 year ARM.

I ran the #’s and this would drop your payment a good bit, keep yourself on an amortizing loan, and give you 5 years of fixed rate at 3.875%. But are you sure you want to trade away a fixed rate for monthly savings and an ARM? I am pretty conservative, so I usually don’t think to talk to people about ARM’s, but if you are sure you’ll be gone in 5 years, maybe the risk is limited?”

His last reply:

“No, I am conservative too. I already take enough risk in the stock market, there is no need to take risk on my mortgage. I’ll keep my great 5% 30 year fixed rate mortgage, and keep paying the debt down. And who knows, I may not be able to retire in 5 years the way things are going, so your reply is the right one. Thanks for talking it through, I can always count on you for an honest assessment.”

There “may” be times when refinancing to an “alternative’ mortgage makes sense, but for the most part when I go through someone’s scenario, I find that the discussion of an ARM or an Interest Only loan was caused solely because some lender who was trying to “make a sale” and not because they had the best interests of the client in mind.

This blog post will definitely be educational, and does have a specific topic. However, it will end up sounding like more of a rant than anything! The topic for today’s blog post is a loan program called the “Refinance Plus.”

The Refinance Plus allows people to refinance who have less equity than when they bought the home. There are numerous guidelines that I will not bore you with, as I want to focus my rant/blog on one specific area of this loan program.

My client originally had a 20% down payment when he bought his homes. After four years the home has gone down in value slightly. Instead of a $400,000 appraisal, which was what he bought the home for, we ended up with an appraisal for $385,000. Since my client had 20% down when he first bought his home and is not paying mortgage insurance, we need to stick to an 80% loan to value so he does not pay mortgage insurance on his refinance. For him to pay mortgage insurance on his refinance would offset the savings in reducing his interest-rate, and would make no sense.

However, 80% of $385,000 would be a new loan amount of $308,000. He had originally borrowed $320,000 which is 80% of the $400,000 purchase price, and he currently has approximately $315,000 left on that original loan. So we are $7,000 short of paying off his car loan, and he does not have that money available to pay out of pocket. He would also have to pay for his closing costs out-of-pocket. So the check that he would have to write at closing is well over $10,000. Had we received a $400,000 appraisal, or even $395,000; 80% of that figure would have been enough to finance the current amount of the loan, and some of the closing costs.

The easy answer to this should be to switch his loan application to the “Refinance Plus” loan program. Since it allows people to refinance with less equity than they originally had, and also allows them not to pay mortgage insurance even if they are going to be over 80% loan to value, this would be the perfect solution. However, one of the requirements of this loan is that the loan must currently be a Fannie Mae loan or a Freddie Mac loan, and then you must refinance it to the same type of loan. My client’s loan was originally a Fannie Mae loan, it still is a Fannie Mae loan, so I decided to refinance it to a Fannie Mae loan. This makes him eligible for the Refinance Plus loan, since we are doing a Fannie Mae-to-Fannie Mae refinance.

However, when I go to the Fannie Mae loan lookup tool, found here: Fannie Mae Loan Lookup; it tells me that my client’s loan is not currently a Fannie Mae loan. And here is where the rant comes in…

I did this client’s purchase loan originally, and I know that it was originally a Fannie Mae loan. My original file shows that it is a Fannie Mae loan. The credit report is showing that his loan is currently a Fannie Mae loan. The settlement papers from the original settlement shows that this loan is a Fannie Mae loan. I called the bank that currently services this loan, and they verbally confirmed that this loan is a Fannie Mae loan. At this point it seems quite simple, and my client should get his loan, correct? Not so fast. The bank that is underwriting the new refinance loan tells me that when they go to the online Fannie Mae loan lookup tool and enter the client address, it is reporting that this loan is not currently a Fannie Mae loan. That aside, everything else shows me that this is a Fannie Mae loan. But the new bank will not approve his refinance under the Refinance Plus program unless they see it show up under the Fannie Mae loan lookup tool, regardless of the documentation in the file. Uhhh….OK, that makes sense.

I proceed to call the bank that currently services the loan, and Fannie Mae themselves, and the new bank underwriting the new loan, and try and get everyone on the same page. I spent over three hours in one day making all these phone calls, and what it boils down to is that it seems that the bank that is currently servicing the loan has mis-entered the address in the Fannie Mae database, and that is why it is not showing up as a Fannie Mae loan. I am inputting the address as it shows on all the official paperwork (mortgage Note, Deed, settlement statement, etc), and the address was input in some format that I cannot guess at. For example is it Street, street, St, ST or STREET? And, is it APT #309, 309, #309, Apt 309, Apt# 309, Apartment 309, etc? The current bank told me the exact way they have it, which is the way Fannie Mae should have it since this bank is the current loan servicer, but I tried that address in the loan lookup tool, and it did not work. I tried dozens of variables of that address, none worked. Everything that I have documented in the file shows that this is a Fannie Mae loan, but my poor client will be unable to get his refinance because of an input error.

I am really unable to finish this blog post because I would have to use language that is indicative of something that goes beyond a rant, and, well, that is just not professional. Suffice it to say that one party is not talking correctly to the other party, and my client is caught in between, and I seem unable to get one party to correct their error with the other party, and everybody keeps point pointing the finger at somebody else.

I will just sum up my current feelings towards Fannie Mae (which is government), government programs, and large banks…they can all go and ‘#!*$!*@&!#!!”

When you refinance your existing mortgage, if you have a home equity line or 2nd trust, the new bank will want a subordination agreement. What is this? Is a subordination agreement some sort of mortgage gibberish, or something that is really needed?

A subordination agreement is something that shows the 2nd trust lender will ‘subordinate’, or stay in 2nd trust place, when the 1st trust refinance takes place.

When a 1st trust is paid off, the 2nd trust automatically goes into 1st trust position. Of course the new lender that is paying off the old lender mandates that they get 1st trust position. Hence, the need for the ‘subordination agreement’ which shows the 2nd trust lender will stay in 2nd trust position, behind the new 1st trust loan.

Timing can be a real problem if a subordination agreement is needed. An existing equity line holder has no incentive to move quickly on processing these, as there is no profit incentive for them to do so. They are seen as a nuisance. Many banks will charge you to process these, anywhere from $75-$150 seems to be the norm.

And, the equity line holder will not process the subordination until they have a copy of the appraisal, loan application and title work. These are things that are not available on the first day of the refinancing process, they usually take at least 2 weeks. And many times an equity line bank will tell you they need 15 business days (i.e. 3 weeks) to process these subordination agreements. So if you need 2-3 weeks to get the paperwork together, and another 2-3 weeks to get the subordination agreement processed, you may exceed the “lock-in” period the new bank has agreed to hold your rate prior to settlement. And if you exceed your lock-in period, you may be subject to higher interest rates than you originally agreed to.

Another possible concern is the “combined loan-to-value.” An illustration will explain this best:

appraisal value of home $500,000
refinance of 1st trust mortgage $300,000
equity line cap of $175,000, current balance $5,000

This should be no problem, right? You only owe $300,000 on the 1st trust, and $5,000 on the equity line (which is $305,000 total amount owed), and with a $500,000 appraisal that gives you a 61% loan-to-value.

What it actually gives you is a 95% combined loan-to-value, because the new bank will use the maximum amount you can draw on the equity line in their calculations (which in this case is $175,000).

In the above example the loan would either be rejected, or they’d make you payoff and close out your equity line, or they’d ask you to modify the maximum cap down to something around an 80% combined loan-to-value. In this case that would mean:

$500,000 x 80% = $400,000
$400,000-$300,000 1st trust = $100,000

The new equity line cap would be modified to $100,000 from $175,000!

So refinancing can be tricky when you have an equity line, as always, talk to a very experienced mortgage professional before proceeding. Calling the 800# of a bank or calling around to every lender in the Yellow Pages may get you someone inexperienced in the subtleties of mortgage rules, and a 30-45 day loan process, an 11th hour loan rejection, and a waste of time and appraisal fees!

There are a lot of questions about refinancing, or at least there should be. The questions a consumer should be asking of a mortgage professional are:

1. What are the closing costs I have to spend to refinance?
2. Can I finance those costs into the new loan amount?
3. How much would I save by refinancing?
4. How long has the mortgage firm been licensed?
5. How long has the individual mortgage professional been licensed? And how long have they been with their current firm?
6. If you are being offered a “no closing cost” loan, are the costs simply being built into the rate so that you are paying simply paying a higher rate in trade for no costs?
7. What happens if your appraisal comes in lower than expected?
8. Will you be required to pay mortgage insurance?
9. If you have mortgage insurance on your current loan can you drop it?
10. How long is the interest rate locked-in for, and what is the turn around time on loan processing, underwriting, and loan document preparation?

And the questions that you “should” be asked by a mortgage professional are:

1. When did you buy the home?
2. What is the current rate on the 1st trust mortgage?
3. Do you have a 2nd trust/equity line, and if so at what rate?
4. Have you drawn on the equity line in the last 12 months, and if so how much?
5. What did you originally pay for the home?
6. What do you believe the home to be “realistically” worth now?
7. What is the balance of the loan amount/s?
8. Is this home your primary residence, a rental property, or a vacation home?
9. What is the property address?
10. What type of property is it, condo, single family detached, rowhome, 2 unit, 3 unit, or 4 unit?

If ALL of the above questions are not being asked of you, and if you are not asking the above questions, there is a strong chance you may not get what you bargained for!

And, you should read this blog post about whether or not you even should refinance in the first place: http://www.getloans.com/blog/?p=335#more-335.

Should I refinance? It seems like an easy question, doesn’t it? But I have read and heard so many different stories, rules of thumb, and methods to calculate whether or not one should refinance it is mind boggling. It is simple, forget all of the rules of thumb that you have heard.

Refinancing is all about asking yourself how much do you have to spend to refinance, and how much would you save. Figuring out what the recapture period is will help you decide if you should refinance or not.

For example, if the closing costs that you would pay to the title company, lender, appraiser, credit bureau, etc. all total approximately $3500, and you are going to save $350 a month by refinancing, then your recapture period is 10 months. And if you believe you will be in the home for 10 months or longer, and the longer you are there the more you will save obviously, then you should refinance.

There is another thing to insert into this question, and that is that if you keep refinancing you will never pay off the mortgage! For example, if you have lived in a house for five years, and have refinanced three times, even if you save money each time on a month-to-month cash flow basis, you also have extended your mortgage such that it will take 35 years to pay off that mortgage instead of 30 years.

For most people that may not matter, because most of us do not stay in our homes for 30, 40, or 50 years. But if you’re going to stay in a house for a long time, possibly forever, you have to be careful about refinancing, and may want to consider a shorter term when refinancing if you have been in the house for quite a while; this way you will preserve your amortization to some degree.

So, at the end of the day, check to see what your recapture period is, and consider how much longer you will live in the home, and make sure you are not refinancing to a new 30 year loan every single time if you’re going to be in the house for the long haul.

And it sounds great to think that you can drop your rate by 1%-2% and can take a 15 Year Fixed Rate mortgage instead of the 30 Year Fixed Rate mortgage you currently have, but you may not save money on a monthly basis. You will save money over the long haul by paying the loan off more quickly, but you may not save money every month. Here are some hypothetical numbers to illustrate the above:

current mortgage:
$340,000 @ 6.375% over 30 years = $2121/mo. (excluding taxes and insurance)

new refinance option:
$340,000 @ 4.5% over 15 years = $2600/mo. (excluding taxes and insurance)

You would think dropping the interest rate almost 2% would certainly save you money, even going from a 30 year loan to a 15 year loan. But you can see you won’t save money on the monthly payment. But…

The 15 Year takes $468,000 to pay off the $340,000. The 30 Year takes $763,000 to pay off the $340,000. If you are in the house for the long haul, take the 15 year mortgage!

As always, make sure you are dealing with a reputable and very experienced mortgage lender. Most lenders will refinance you just to get the commission, with total disregard for whether or not you really should refinance!