Monday, October 10, 2011

Refinancing a Mortgage

As you've no doubt heard, mortgage rates once again at historic lows. I've thought about refinancing, but I think I may just leave it alone for now, as it just may be too much trouble. The background on why relates to the story below.

A friend of mine, who I'll call Maud, is currently in the process of refinancing a property. In the course of talking to her about this, she told me all this interesting stuff about the history of her home-ownership. This all starts about 30 years ago, when Maud's parents sold their share of a small business and suddenly had some cash to invest. They decided to buy an apartment in NYC, figuring that their kids might rent it from them while they were students, and they could rent it to other tenants as well. After one of those other tenants left, Maud decided she wanted to settle in the apartment long term, but the problem was that she wanted to buy rather than rent, but the apartment was too expensive for her at that time. Meanwhile, her parents had also decided to buy another property elsewhere as a vacation home. They ended up inviting Maud to buy a share in the vacation home at a level she could afford.
Now this sounds weird, but it all ended up being part of some complicated tax shelter scheme, which allowed Maud to swap her part-ownership in the vacation home for shares in the NYC apartment over time. There was a big tax advantage for her parents, and for Maud the advantage was that she borrowed privately from her parents and stretched out the purchase in a way that made it more affordable. Over time, Maud's income increased and she was able to pay off the loan from her parents early, leaving her in full possession of her apartment. This all sounds kind of odd, but Maud insisted that she paid her parents the full appraised value of the apartment plus interest. As a real estate investment, it didn't turn out that well for her parents since the market crashed after they first bought the place, but I guess they at least saved on paying some capital gains taxes. This would be an example of the sort-of-rich getting sort-of-richer based on hiring good lawyers!

Anyway, a few years after Maud paid off the apartment, she was doing very well in her career and had saved a lot of money, since her monthly costs were quite low without the mortgage. She started thinking about real estate investments herself. She looked at properties outside the city and came across an inexpensive, very small, but charming house. It was so charming, in fact, that she decided she wanted it for herself and bought it to use on the weekends. She admitted that it was a rash decision and not exactly the kind of "investment" she'd had in mind! But she loves having the house as a retreat, especially since her city apartment is also fairly small and she can use the extra space, which seems cheap compared to buying a bigger apartment in the city.
When she bought the place, she got a fixed-rate mortgage of about 6.5%. So of course the rates we've been seeing in the last few months were very attractive to her, and she decided to refinance. But here's the reality of what's happened in the last couple of years: banks are actually being a lot more picky about who they'll lend to these days. Because the market value of her house was down since she bought it and because there were some other complicating factors, the bank that held her existing mortgage didn't want to refinance it, and it was unlikely any other bank would either.
(At this point, my question to Maud was why the same bank would ever want to voluntarily lower the rate on a mortgage from 6.5% to 4.5%-- sounds weird, doesn't it? But aside from not wanting to drive you to their competition, and benefiting from the fees that the refinance transaction generates, Maud pointed out that the rate itself is a wash for the bank, as they are always pricing the mortgage as a spread from the prevailing rate set by the Federal Reserve.)
Back to the problem with refinancing: Maud was a bit dismayed, but her very sharp loan officer came up with a great solution: instead of refinancing the weekend house itself, why not take out a new mortgage against the paid-off apartment and use that cash to pay off the house in full? The apartment had gained a lot in value over the years, so she had way more equity there than the value of the house. She'd be nowhere near the usual loan-to-value ratios banks would require for a mortgage. All in all, it was a brilliant solution, so Maud forged ahead with the application.
As the process went along, I began to compare her updates with the process I'd gone through to get my mortgage at the height of the real estate boom. It was amazing to me how exacting they were being about every little detail, verifying addresses she'd lived at 30 years ago, asking for all kinds of documentation on the monthly costs of both her homes and the finances of the co-op. An appraiser came and did a whole report with photos and floor plans of every room attached. And this is all for someone with a high income and a perfect credit score, whose apartment is in an established building with other recent sales. This was definintely not a "liar loan!"
Maud also said that the good faith estimate and other application paperwork she received was very clear in its disclosures of the terms. So if anything good has come out of the economic crisis, it may indeed be that our real estate market will now have more stable underpinnings, with mortgages only given to people who can afford them, for properties that are actually worth it.

But back to my situation: I put 20% down when I bought, and I've paid off some extra principal over the last couple of years, but I'm not confident that my apartment would be appraised high enough if I tried to refinance now. It might also be a concern that the developer still owns some of the units in the building. I'm also wondering about selling the apartment in the next few years-- I think I'll be renting it out soon and moving in with Sweetie, but I don't want to be a landlord forever. So it's a dilemma... I may make some inquiries anyway, so I can assess this based on real info rather than my own gut feelings. I'll of course keep you posted when I do!


Anonymous said...

At one time as recently as last year, banks like ING direct were allowing home equity loans with terrific rates and no points up to 95% of the appraised value--if I hadn't sold my house, I would have taken out the home equity loan and used it to directly pay a chunk of principal on my primary mortgage, then converted the HELOC to fixed rate. The only downside was that the HELOCs converted to ten year loans rather than thirty, but it seemed like the savings were definitely worth it. I figured out I'd earn back the closing costs within 12 months.

mOOm said...

Why don't you "want to be a landlord forever"? Get someone to manage it. It'll reduce your returns but save you a lot of hassle.

asian furnishings said...

If you can not able to purchase any property or any other thing so you can take loan.There are many banks providing this facility for their customer's convenience. And their rates and down payment are also in budget.

Mutual Fund Investment said...

If you are interested in Mortgage Refinancing, it is normally for one of two reasons. Either to get a lower interest rate to save money in interest payments over the life of the loan. Or, you are interested in refinancing with cash out.

Mortgage refinancing can be done in a number of ways. The two most common are going to your local bank or using the internet.

The internet is becoming a more and more popular method of mortgage refinancing by the day.

Some of the reasons are obvious, mortgage refinancing over the internet is very simple, and the information you can find on the mortgage industry is limitless.

The mortgage industry is a very competitive one, so using the internet to shop around for mortgage refinancing is very smart. As opposed to using your local bank that normally has one product for you to choose from.

Anonymous said...

It is a hassle, but I've done it twice--once in 2009 to go from 30yr fixed 5.375% to 30r fixed 4.875% with same bank and this year to go to new bank's 30yr fixed 4.125% (btw, my apartment was appraised at $120K less than in 2009). I could have gone to 20yr at 4% or 15yr at 3.75%, but given the accelerated payments I'm already making, I plan to finish between 15 - 18 years. The reason I didn't choose the lower rates was for flexibility, especially as maintenance costs standard for NY co-ops go up every year. Closing costs are recouped in a year and a half, and I do plan on staying put. Each re-fi has saved about 2K a year, which I put toward principal.

Anonymous said...

Banks are pain in the butt these days. They ask for ridiculous things that have nothing to do with actually evaluating the risk. I refinanced earlier this year and had to explain on why I have ZERO balance on a store credit card. That's right, I had to write a letter explaining why I DON'T OWE money. Totally ridiculous! They swing from one extreme to the next. Bunch of idiots. No wonder they were in such trouble.

Suzanne said...

I wouldn't want to be going through the loan qualification process right now. I've got 7 years left on a 15 year loan at 5%. I think I'll stay where I am for many years, so it makes sense to me to NOT refinance.

Jon said...

I like to look at the refinance from a numbers perspective. Given your current interest rate, and your prospective new interest rate, you can figure out your monthly savings by refinancing. There is some trickery in here too, if you say have 26 years left on a 30yr fixed and refinance to a new 30yr fixed-- you'll end up with a little more savings but less going to principle initially. It is extra cash flow though.

Given that savings, there is a pay off date for the cost of the refinance. (total cost/monthly savings) For my past NYC coop refinance in 2009, it was about 6 months, as generally coop refinances are relatively cheap.

Thus, even if you only expect to own the home for 2 more years, that may be 18 months of savings you can pocket. At $100-$300 a month savings, or whatever your number may be, that isn't too bad. You also may find you own this apartment longer for a longer period, due to circumstances later.

As for LTV ratios... if the savings is good, you can start the refinance process and get the appraisal done for about $400 as an investigative step. After you get the value back you can decide for sure how to proceed based on the numbers. The problem biggest problem being that if you're at less than 20% you may get tacked with PMI, which is a nightmare you don't want to add to your loan. It's probably $100-$150 a month. If the value is only like $10k below the threshold (or something you have comfortably in cash lying around), it could be worth paying down the mortgage with the refinance to get the savings, plus the 4% return no the pay down part.

It's all in the numbers. Another tip, find a decent mortgage broker to go to. Usually he can quote you a rate that is at least 0.25% below most big local banks, and it will end up being with one of them anyway.

Bill said...

Maud clearly doesn't understand finance or fixed-income. Refinancing your mortgage is not a wash for the bank. High coupon bonds trade above face value, low coupon bonds trade below face value, as do loans. The bank would take a substantial hit by refinancing a loan like hers. 6% Fannie 30 year bonds are trading around 109.7% of face value today. Turning that into a par bond is far from a wash.