Sunday, July 8, 2012

Fun With Housing Finance

The Mechanics of Refinancing In a Mortgage Market Gone Crazy

As should be obvious to anyone watching the markets, mortgage rates have fallen to record lows once again.  Turmoil in equity markets, sovereign debt fears and probably expectations about central bank actions have continued to drive interest rates lower on a wide variety of fixed income instruments including agency mortgage backed securities (MBS).  For conforming mortgage loans, yields on MBS drive pricing and rates on loans.  However, the mortgage market is a bit of a mess in the wake of the real estate crash and the dissolution of a large part of the mortgage origination machinery in the last several years.  The silly-low rates being dangled in front of would-be borrowers come with a bunch of strings attached and if you do not meet the many requirements to qualify for the advertised rate you are likely to pay far more in rate/fees or simply be unable to borrow at all.  Since the list of requirements moves around not infrequently, potential borrowers who are on the edge will have a tough time figuring out if they qualify until they actually commit time, money and hair-pulling to an application.

Late last week I locked a rate to refinance my current mortgage.  I will now explore the whys, hows, and what has changed over time in the mortgage process.  I am lucky enough to comfortably meet the current requirements for receiving the advertised rate, so my comments will largely be confined to the so-called "conforming" mortgage market.

Before I get into the details of what I am doing, it is worth discussing why I even have a mortgage on my residence.  There are a number of people who have made it a priority to own their homes outright, with no mortgage of any kind outstanding.  This usually requires either paying the loan off with a lump sum or aggressively paying the loan down faster than is required over a period of years.  While being mortgage-free is certainly attractive, it requires trade-offs.  Chief among these is that you would have to devote much of your income or assets to paying off the mortgage early which would not allow one to take advantage of the many investment opportunities that crop up from time to time.  While your returns will be volatile compared to the steady required interest of a mortgage, choosing this path isn't always about returns.  Having the flexibility to deploy your capital at a moment's notice is a valuable option and one that you do not have when you use that capital to retire your mortgage.  All of this said, there are definitely two schools of thought as to whether you should try to be mortgage free or not, and there are clearly benefits to not having a mortgage (sleeping well at night, never having to worry about default, etc.).

So what am I doing?  Currently I have a 3.5% 5/5 ARM I took out a year ago when I purchased my home.  At the time I wanted a simple, low cost product from a lender ( I had dealt with in the past and this loan fit the bill.  Pen Fed ate all the closing costs and the rate was a full percentage point below a 30 year fixed mortgage at the time.  The structure of the loan is that the rate is fixed for 5 years after which it refloats every 5 years and the rate cannot move more than 2% at each adjustment.  This is different from a standard 5/1 ARM which allows the rate to move every year after the first 5 and the initial interest rate can change as much as 5% at the first adjustment.  So the 5/5 has far less "payment shock" ("holy cow did the payment go up!") risk than the standard 5/1.  That said, the possibility of getting hit with rate increases in the future has been a nagging worry in the back of my mind for some time, so I have been watching 30 year fixed mortgage rates to see if I would have an opportunity to eliminate this risk.  I would have been willing to accept a slightly higher rate than what I already had, but on Friday the monthly US employment report came out looking pretty anemic and the market again shoved rates down hard.  I was able to lock a 30 year fixed mortgage with a rate of 3.5% and a 1/4 point credit toward closing costs.  Total closing costs net of the credit will be just over $1,000.  I easily spend $3,000 annually on various forms of insurance (home, auto, umbrella, term life), so a one-time cost of a thousand dollars to wipe out all my interest rate risk seems acceptable to me.  If I ever have the chance to refinance at a lower rate I will be happy to do so, but I suspect that I will not be given that opportunity.

Despite some changes, it is still hard to get a straight answer on costs from most lenders.  Calling up several mortgage brokers and lenders and asking for rates and fees will probably only show you who is the best liar.  So how do you monitor rates and jump when the time comes?  First, you can watch MBS prices/yields and interpolate from that.  A Bloomberg terminal would be your friend for that task, but those without access might find daily price moves in MBB (an ETF that holds agency MBS) helpful to watch.  Another source of information (for rates and almost everything else) is the Mortgage Professor's site which offers numerous calculators, articles, and daily wholesale loan rates (your retail rate would be higher, but movements in the wholesale rates would be closely tracked by retail rates).  Finally, some lenders have chosen to be transparent and commit to showing you as much as they can up front.  I monitored rates and fees at and chose to lock my rate with them.  I cannot recommend them yet because I am early in the process of getting my refinance completed, but thus far they seem to be taking pains to make things as simple and straightforward as possible.

What has really amazed me is how the mortgage process has changed over the last 15 years.  When I took out my first mortgage in 1998 it was a 15 year fixed from a local bank that I knew would end up keeping the loan in its portfolio (not selling it).  All I knew going in was the rate, with closing costs pretty much a mystery.  Everything had to be done with paper and fax machines, and the lender was obviously doing its own credit work because they asked a bunch of persnickety questions that came from a person who was actually thinking.  Fast forward to today and everything is electronic.  In 50 pages of agreements and disclosures that had to be signed or initialled, all but 5 pages were able to be electronically signed and the remaining pages I scanned and uploaded to the lender's website.  The rest of the requested documents were either pdf bank statements or scanned physical documents I had on hand that I uploaded.  I have no idea who the actual funding lender is and the loan will almost certainly be sold off as soon as possible.  The underwriting is being done against agency standards and will probably be done within software provided by one of the agencies.  I would be very surprised if I get any underwriter questions that do not originate from needing to check off a box provided by one of the agencies rather than from a human being thinking and doing real credit work.

As of yet, I am waiting for the lender to set up an appraisal and move along with the process.  Since this is a refinance and not a purchase, my risk on this deal falling through is pretty limited ($31 for the credit reports and whatever the appraiser charges).  Aside from lender incompetence, the major reason refinances fall apart these days is an inability to show enough equity in the property due to declining real estate values.  I am fortunate enough to have bought a year ago in a market that has been on a grafdual upswing, so I don't expect to have LTV issues.  But what if you do have trouble getting below an 80% LTV?  If arguing with the appraiser does not work, you can either abandon the refi, bring cash to the table to bring the LTV down to 80%, or pursue a HARP refinance if you are eligible (see  HARP refinances are a lot of trouble and tend to be expensive, so if at all possible I would recommend simply paying down the mortgage balance in order to comply with the 80% LTV limit.

I plan to update the blog on how this refinance goes once the dust has settled.  It will be interesting to see if my very plain vanilla situation goes as smoothly as it should.  Lots of people are refinancing, so I expect the lenders to be strained to process everything in a timely fashion.

As always, do your own due diligence, be careful, consult youtr advisors and watch your wallet.

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