Guest Post

The criteria for refinancing a mortgage through a traditional lender typically require some degree of equity in the property. At the very least, homeowners should not owe more than the home’s value in order to qualify for the best refinance rates.

After the housing market crashed in 2008-09, many homeowners found themselves struggling to refinance their mortgages in light of sinking home values and disappearing equity. However, there is hope for refinancing even for borrowers underwater with their current mortgage.

Home Affordable Refinance Program

The Home Affordable Refinance Program, better known as HARP, was designed to help homeowners refinance their homes with stable, affordable mortgage terms. A joint effort by the Department of the Treasury and HUD, the HARP concept was designed to address the problem of lost home value compared to mortgage balance owed.

Certain criteria are required in order for a borrower to qualify for a HARP loan. Primarily, borrowers must be current on all mortgage payments, with no more than one late payment in the previous 12 months. Additionally, the loan must be owned by Freddie Mac or Fannie Mae. Initially, the ratio of loan to home value had to meet qualifying criteria, but those standards were changed in 2011.

Individual lenders are responsible for processing and approving applications. Not all mortgage servicing companies make HARP available, as involvement with Freddie Mac or Fannie Mae is required. If available through a lender, refinancing under HARP does require the origination of a new loan, with all the subsequent fees and underwriting requirements typical of a refinance. The program does not guarantee the best refinance rates, but instead strives to help homeowners refinance into a more affordable payment and interest rate.

FHA Streamline Refinance Program

Whether a borrower qualifies for HARP or not, there are options available for refinancing, even when the value of the home has dropped. For example, borrowers with The Federal Housing Administration (FHA) mortgages may be eligible for streamline refinancing. Like HARP, the FHA Streamline Refinance program may not offer the best refinance rates, depending on the borrower’s credit history and income, but the program does help homeowners who are under water with their mortgages.

Various criteria and terms are available through FHA lenders provided the mortgage is current, the loan is insured through FHA, the refinance lowers monthly payments and no equity is cashed out. As with HARP loans, loans eligible for FHA streamline refinancing vary, depending on specific lender terms. Some borrowers may qualify for no-cost refinancing with a higher interest rate. Others may have their closing costs rolled into the new loan, to take advantage of lower rates.

Individual Lender Refinance Programs

For homeowners whose loans are not owned by Freddie Mac, Fannie Mae or FHA, many individual lenders offer programs to help refinance underwater mortgages. No matter what lender owns the mortgage note, borrowers should start the refinance process by first asking their current lender what programs the lender offers and for which programs the borrower qualifies. From there, the borrower can pursue other options to ensure the best refinance rates and terms for their situation.

This post is brought to you by Refinance Mortgage Rates, a consumer organization with the mission of educating and informing in a time of economic uncertainty. We publish and spread accurate content to help consumers avoid the pitfalls of the mortgage and real estate market.

Related Posts:

Save for Retirement Now or Payoff Your Mortgage First?
Five Reasons the 30 Year Mortgage Beats the 15
Why Paying Down Your Mortgage is More Important Than Ever
Is Now a Good Time to Refinance?
Adjustable Rate Mortgages – You’re Kidding, Right?
5 Reasons to Buy LESS House Than You Can Afford

By Kevin M

For generations the conventional wisdom on housing was always to buy the most (or more) house that you can afford. The rationale—which worked for decades—was that a house was the closest thing to a guaranteed investment, and by buying the most expensive property you could afford you were insuring the greatest possible payoff over the long run.

That thinking caused many households to go deep into debt in order to make it happen, which created a vicious circle of greater debt feeding higher property prices.

What a difference a few years can make?

The entire conundrum went full circle, with property prices rising consistent with higher mortgage levels, until the borrowing party stopped. Suddenly John and Jane Q. Homeowner could afford to borrow no more, and the whole property construct has gone into the ditch.

Will we get out of that ditch anytime soon? Maybe…but maybe not, at least not for a long time.

Rather than speculating as to when the long awaited turnaround will occur, it might be better to plant our feet firmly in the ground that is now, accept our new reality and make adjustments in our housing expectations that are consistent with that reality.

Now is the time to reverse the psychology that drove both property prices and debt to dizzying levels and adopt a new strategy: buy LESS house than you can afford! Why?

There is no job or career stability

Despite the plethora of no doc and no income verification loans, the fortunes of the housing market have always rested squarely on employment. Since most properties are acquired primarily through debt, employment and career stability have always been the unseen foundation beneath property prices.

Whether through technology or off-shoring of jobs to countries with lower wages, the trend in business is now the reduction in both staffing and payroll levels. This trend has been at work for many years and shows no sign of reversing.

Meanwhile jobs and careers that were once thought to be safe are no longer, and those considered secure today have little in the way of long term certainty. It’s critical then for homebuyers to buy with the assumption that their incomes could be lower in the future than they are at the time of purchase.

We can no longer assume property values will rise

If house prices have always been based on employment, then mortgage lending has always been based on house prices. Rising prices not only meant higher mortgage loan amounts, but they also functioned as a borrower fail safe: if you could no longer afford to make the mortgage payments you could usually sell the property for more than you paid for it.

The mortgage would be paid and you’d walk away with a cash windfall, free to go on and make your next move in life. It was a cozy arrangement while it lasted.

But property values in much of the US, the UK and Europe have fallen, often substantially, and continue to do so to varying degrees. This means no more borrower fail safe—rising property values can no longer be counted on to solve mortgage problems. It may be critical that you buy a property for even less than current market value.

Selling a property is neither certain nor inexpensive

The same factors that are lowering house prices are also making them difficult to sell. Mortgage lenders, stung by the wave of foreclosures that seems to have no end, have tightened lending standards. Fewer people now qualify for mortgages, and that reduces the pool of potential buyers.

There’s also the issue of cost. Trying to sell a house in a buyers market is not only more difficult, it’s also more expensive. In a strong market you might be able to sell your property without a real estate agent; in this market you almost have to have one, and that mean’s you’ll pay a commission. It may also mean you’ll need to pay part or all of the buyer’s settlement costs, another sales expense that may not have existed in better times.

The time and expense needed to sell a property might make doing so impractical. Be sure to consider this fact when buying a new home.

Non-mortgage housing costs are rising

One of the best features of a mortgage—if it’s a fixed rate—is that your payment is locked in at purchase and can never rise. But that can’t be said of other housing expenses. With local governments facing budget shortfalls, property taxes are rising. Homeowner’s insurance premiums are also rising, and utility costs are bouncing all around with the rise and fall of oil prices. Repair and maintenance costs are also increasing now that people are forced to stay in their homes longer than in the past.

The only control a homeowner or buyer has over their housing expenses is with the mortgage itself. For this reason, it’s vitally important to make the best deal on a mortgage that you can. Loan rates and fees vary from lender to lender, and having a reliable e-mortgage calculator is the first step toward getting the best deal on a mortgage.

You may actually have to pay off your mortgage!

Leverage has been a central component in the real estate market for a very long time, so much that few people questioned its use until the current housing collapse. The idea was to put as little money down as possible, maximize the mortgage financing, and keep rolling the loan over every few years, either to get cash out or consolidate debt. If we’re honest, paying off a mortgage was never the goal—that has a lot to do with the mess we’re in now.

But today is a new day, and the game has changed. In the housing and mortgage environment we’re in now, and will be for the foreseeable future, you need to have a concrete intention and plan for paying off your mortgage! Again, this will mean getting the most favorable mortgage terms possible. Use an emortgage calculator, investigate as many lenders as possible, and be sure to get the best deal available.

Do you think the real estate market will improve soon? If not, what advice can you offer that will help both homeowners and buyers cope with a weakened market?

Related Posts:

Five Reasons the 30 Year Mortgage Beats the 15
Save for Retirement Now OR Payoff Your Mortgage First?
Why Paying Down Your Mortgage is More Important than Ever
Is Now a Good Time to Refinance?
What Would You Advise a Friend Facing Foreclosure?
Want to Save Thousands on Your Mortgage? Fix Your Credit

By Kevin M

Rates for fixed rate mortgages are below 5% for a 30 year loan, and down close to 4% for 15 year loans. So is now a good time to refinance? Maybe. And only maybe.

If you have an adjustable rate mortgage (ARM), a funky ALT-A, a variable home equity line of credit that can be consolidated, or most definitely a sub-prime deal, refinancing is a no-brainer. You’ll probably get better terms and a much better rate, so do it and don’t delay. No one ever needed a six month, interest-only ARM with negative amortization in the first place!

It’s not all about rate!

But if you refinanced or purchased your home during the last rate bonanza, and have a fixed rate loan in the 6% range, you really have to do some number crunching to see if it’s worth it. Refinancing isn’t a contest to get the lowest rate possible. You have to determine if a refinance works within the parameters of your own personal circumstances. Sometimes, refinancing can even be a step backward!

Some reasons you may NOT want to refinance, even at these historically low rates…

Closing costs. Spending $5000 for closing costs to get a $50/month advantage will probably be a step back for most. The recapture period on that will be 100 months ($5000 divided by $50 per month in savings), or greater than eight years.

A common rule of thumb in the mortgage industry has traditionally been a two year recapture period. A refinance might make sense if the recapture is longer than that, but two years is realistically the outer range of predictability, after which crystal balls tend to fog up.

Statistically, most people don’t carry a mortgage for more than 5-7 years before selling or refinancing again–factor that into the projection even if you’re certain you’ll be in the house for 20 years. The reality of life is that circumstances do change, so it’s best not to assume permanence. Think about how many times you’ve moved or refinanced in the past 10-20 years–that’s your reality.

Loan term. If your current 30 year mortgage has 25 years remaining on it, you’ll reset the loan to 30 years by refinancing, which puts you back at square one. Might that affect your retirement plans?

You could get around this problem by making the new loan a 25 year term instead of a brand new 30 year term. On a $150,000 mortgage at 4.75% however, this would raise the new payment from $782 per month, to $855. In my many years in the mortgage business I can tell you that the human tendency is to opt for the lower payment in 90% of refinances. After all the numbers are crunched, most people refinance to improve their cash flow. But long term, cash flow isn’t improved if an extra five years are added to the back of the loan.

An uncertain future. Life just isn’t as stable as it once was. Jobs come and go, career changes are no longer unusual, the divorce rate is embarrassingly high—all of these changes often require mobility. Under closing costs above we talked about the recapture period on closing costs, but it rates another discussion here.

Mortgage financing is long term in nature, so it’s not possible to consider it in a vacuum that assumes perfect world conditions. How stable is your job? Is a transfer or job loss a distinct possibility in the next couple of years? If you were to lose your job, could you replace it with a comparable position in the city where you live, or would the loss require a geographic move? Is the likelihood of a move a real possibility in the next few years?

Compare the closing cost recapture period to that time horizon; no matter how low the rate, it isn’t worth having if you won’t be in the house long enough to get a benefit from it.

Declining equity. If you had a loan equal to 80% of the value of your home when you bought it, but the value has dropped and a refinance would mean a new loan equal to 90 or 95% of the value, you will have to pay mortgage insurance on the new loan. This is the equivalent paying a higher interest rate, but in many cases, the additional payments won’t be tax deductible.

Unfortunately, it gets worse.

Mortgages today are priced based on risk. A 90% loan is considered to be a higher risk to the lender than an 80% loan would be, so there is a higher rate for the 90% loan. The rates you see published are for the best credit risks; as your profile departs from perfect, the rates go up. It’s possible you won’t get anything close to the rates you see published.

Your remaining term is below 15 years. This is especially true if the remaining term is 10 years or less. The shorter the remaining loan term, the less rate matters and this is because principal repayment makes up the bulk of the payment.

An alternative to refinancing

If refinancing isn’t a practical option, or if your equity or some other factor has declined to the point that a refinance won’t be available, consider putting any closing cost money you would have paid for a new loan into the existing loan, and work on accelerating the payments. How much could several thousand dollars paid into your mortgage now shave off the term of your loan?

As stated above, the lower the mortgage balance, the less interest rates are a factor. Ultimately, the goal with a mortgage is to get it paid off, so if a refinance won’t work in your situation, go back to Plan A, and work on paying the loan off.

Are you considering refinancing? What advantages or obstacles are you running into?

By Kevin M                                                        

One of the most compelling reasons for owning a home is the heavily touted tax benefit owing to deductions for mortgage interest and property taxes. Real estate agents will play this benefit for all it’s worth in extolling the idea of homeownership for all.

However for three reasons, this benefit is not what it used to be: a generous standard deduction, low mortgage rates and low marginal tax rates.

The tax benefit of homeownership became an entrenched concept back in the 1970s and early 1980s and at that time it had overwhelming merit. Mortgage rates were in double digits most of the time, marginal tax rates ran as high as 70% and standard deductions were down in the low thousands. Owning a home made major sense even for moderate income earners and was an article of faith in the higher income brackets.

None of that is true today, yet the tax savings pitch remains. Standard deductions can exceed $11,000, interest rates are down around 5% and marginal tax rates cap out at 38% (but are substantially lower for the vast majority of households). Yet the notion of major tax savings remains almost unchallenged.

The rules have changed

The tax code as it stands in 2009 is far more taxpayer friendly than it was back when tax benefits had become one of the holy grails of homeownership.

For 2009 the standard deduction is $11,400 for married filing jointly, $8350 for head of household, and $5700 for single.

Marginal tax rates are as follows:

Married filing jointly:
0 – 16,700 10%
16,700 – 67,900 15%
67,900 – 137,050 25%
137,050 – 208,850 28%

Single:
0 – 8,350 10%
8,350 – 33,950 15%
33,950 – 82,250 25%
82,250 – 171,550 28%

The personal exemption is $3650 per person.

Note also, that the deductibility of tax sheltered retirement plans, health insurance premiums, qualified child care expenses and cafeteria benefit plans reduce pre-tax income and can keep a taxpayer in even lower marginal tax brackets. Every situation must be considered based on the facts of one’s own situation and never generalize.

A working example of the diminished tax benefit

A couple with two dependent children, earning $85,000 per year, is considering purchasing a home for $250,000. They have $50,000 for the down payment and plan to take a $200,000 fixed rate mortgage loan at 5% for the balance. First year interest on the loan will be $10,000 and real estate taxes will be $3000, both of which are deductible for tax purposes. So far, so good.

But when they go to file their income taxes after their first full year in the home, the tax benefit windfall they were expecting yields a stark disappointment.

Mortgage interest……………….$10,000
Real estate taxes…………………..3,000
State income taxes………………..5,000
Charitable deductions…………….2,000
Total itemized deductions……$20,000

Deducting $20,000 in itemized deductions and $14,600 in personal exemptions (4 X $3650) yields a taxable gross income of $50,400, which puts the couple in the 15% marginal tax bracket.

$20,000 in itemized deductions looks pretty appealing at tax filing time, but remember, the IRS was giving this couple $11,400 without itemizing. The benefit of owning the home and itemizing will only apply to $8600 in income (20,000 minus 11,400)!

At the 15% marginal tax rate, this translates into a net tax benefit of only $1290 per year! That’s the equivalent of a $107.50 effective reduction in their monthly house payment.

A $200,000 30 year fixed rate loan at 5% interest will have a payment of $1074 per month. Adding $250 for real estate taxes ($3000 divided by 12 months) and a $75 per month estimate for homeowners insurance gives a monthly payment on the home of $1399. If we deduct the $107.50 per month tax benefit, that produces a net payment of $1291.

Certainly this couple will appreciate the tax savings, but the following questions emerge:

1. Will this tax benefit represent a major reason in favor of purchasing this home?
2. Will the benefit outweigh the higher cost of maintenance that comes with owning a home versus renting?
3. Will it offset the opportunity cost of having $50,000 tied up in a down payment rather than earning interest or investment income?

It gets even worse

If the size of that tax benefit seems surprisingly small, consider that as the loan balance declines, the amount of interest paid will decline in step, further eroding the tax advantage of the mortgage interest deduction.

In addition, since the federal tax code adjusts to ever-present inflation, standard deductions are increased over time, while tax bracket thresholds are increased, gradually reducing the tax benefit even more.

Even if there is a modest tax benefit to owning home in the first few years, it will gradually disappear the longer you’re in the home.

None of this is meant to minimize the potential tax savings from homeownership—a single person with a six figure income for example may realize a substantial advantage. However, the benefit of income tax reduction should be carefully examined by anyone wanting to purchase a home to determine if it’s even relevant in their specific circumstances. For many, many households—perhaps even for the majority—it won’t be.

And other questions you should ask before buying a home!

By Kevin M

Many articles have been written on the buy-verses-rent question, but most of the analysis tends to center on the dollars and cents side of the question. We read about tax advantages, investment potential, home buyer tax credits, income ratios—all important considerations, but all essentially monetary in nature.

Rather than crunching numbers, I’d like to consider the question from a mostly non-monetary angle, and discuss factors which are of at least equal importance in making the decision to buy or rent a home. Most have to do with lifestyles, attitudes and future prospects.

Employment mobility

How stable is your job? That’s a question that probably didn’t need to be asked a decade or more ago, but it’s crucial now. It isn’t just that jobs have become less certain, but also because the ability to profitably flip a house every 3-5 years to follow a new job isn’t an option any more.

People who work in healthcare, education, local government, or who are self-employed in established local businesses have the kind stability that support long term home ownership. Almost ironically, having a successful portable business—one that isn’t dependent on location—can also provide stability.

However, if you’ve found yourself experiencing regular job transfers, extended periods of unemployment or if you work in a location where parallel opportunities in your line of work are rare, renting may be the better option.

Do you have, or plan to have a family?

A family is a major reason to own a home. Room to grow and a sense of permanence can’t be measured in money alone. Even more compelling: if you have—or expect to have—an aging family member to care for in your home, owning will be the better choice.

Activities, hobbies and trades

From a pure financial standpoint, it may be cheaper to rent, but what if you like to work out and have a lot of exercise equipment? You probably won’t be able to store it—let alone use it—if you live in an apartment.

Likewise, you probably will be unable to create a garden, keep more than a single pet or run a plumbing business out of a house that you rent. If you have activities that are an integral part of your life or livelihood, you’re probably better off owning your home, even if it costs more money to do so.

Dead equity

It’s gotten much more difficult to qualify for a mortgage to purchase a home with a minimal down payment. The most basic alternative is a larger down payment, typically at least 20% of the purchase price.

We’re talking $100,000 on a $500,000 house, and that will be dead equity. You won’t be able to tap it for emergencies, investments, to buy a car or to help a sick or struggling relative. (Note: home equity lines are no longer easy to get!)

Do you have sufficient funds available for these contingencies over and above your down payment? Are you OK having most or all of your money tied up in a single asset? If not, renting may be the better option.

Would you buy a house if it didn’t rise in value?

The house price spiral of recent decades has fostered a sense of necessity: buy now or it will cost more later. Simply put, higher prices drove higher prices. Real estate turned into a tangible get-rich-quick scheme forcing us to buy in as early as possible. A house was no longer a home, but an investment, and like all investments, it succumbed to the boom/bust cycle.

If a house won’t be an investment—meaning it won’t be worth substantially more in X number of years—would you still want to buy it?

Life in transition

During my many years in the mortgage business I’d often wonder why a person coming fresh out of college, a divorce or a financial catastrophe would feel compelled to buy a home. I’ve always suspected it had to do with that price spiral discussed above.

Is an immediate home purchase is the right course for newlyweds? I’ve seen a sufficient number of recent marriages break up within the first two or three years, complicated by a house that needed to be disposed of. In today’s market, selling that soon will most likely require the seller to write a check at the closing table.

If you’re in a period of natural transition, such as those listed above, would you not be better off renting until your life becomes more settled?

Repairs, maintenance and remodeling

These are the great variables that most would-be homeowners ignore. Fact: even if your projected mortgage payment is no higher than your current rent payment, it will still cost you more to own a house than to rent. In a typical house, repairs and maintenance can average several thousand dollars per year; periodic remodeling can run in the tens of thousands. Are you prepared for this?

How much do you like your free time?

Repairs and maintenance will cost not only money, but also time. As an owner, you’ll need to maintain your lawn, fix what breaks, shovel snow and handle any chore your landlord is probably doing for you now. Generally speaking, owning means less free time.

If you have a job or business that takes up most of your time, owning your own home could compete with that. Are you a fitness buff? Owning may compete with that as well.

Alternatively, if you have a family, taking care of the home together can be a shared experience, as you maintain and improve the home as a joint venture.

Buy with the intent of paying off your mortgage

The concept is virtually old fashioned, but how many people buy a house with not only the intention, but also a plan for paying off the mortgage ahead of schedule? If your house doesn’t rise in value over the next 10-20 years, the primary investment value of owning will be paying it off to own it free and clear as soon as possible.

Are you committed to doing this?

Buying beneath your means

The real estate industry has done a superb job of convincing home buyers to purchase at the maximum of their ability, or even higher. More than a few homeowners are now facing the fallout of that choice. Alas, deep recessions and house price declines are not only possible but here we are.

When you buy at the maximum of your affordability you deny yourself any flexibility in the event that perfect world assumptions don’t pan out. If possible, purchase a house that’s about 1/3 below your maximum; if you lose your job, you probably will be able to get one that pays 1/3 less than you now make in a relatively short period of time.

In the meantime, you’ll be able to save some money in case that rainy day comes. If it never comes, you may be in a position to accumulate some real wealth, a little at a time!

Are you ready to buy beneath your means? If you aren’t, then ego may be driving your purchase decision more than logic or good sense.

 
Neither owning nor renting is the right choice for everyone, but owning clearly carries greater risks. Have you considered or prepared for those risks?

Can you think of any other non-monetary factors that should be considered in deciding to buy or rent a home?

STRATEGY #9 TO SURVIVE A DOWN ECONOMY

By Kevin M

In the best of times, borrowing seems to be a sensible way to get the things we want but can’t afford to purchase in full right now, but we’re sure we can tackle later with a predictably increasing income stream.

But when economic fortunes shift into low gear—as they are now—the same debt accumulated during better times can become a heavier burden, even one which is impossible to bear. Other than paying debt down and eventually off completely, there isn’t much we can do about the debt already accumulated. But the Great Recession should be a wake up call to all who might have come to view debt as a traveling companion in life.

In 10 Ways To Survive a Down Economy (published on Christianpf.com June 1) we listed ten strategies to help you deal with the bad economy. Our topic for today, Strategy #9:

”Envision a future without debt, and then pursue it.” Gradually pay down—then pay off—your debt. This includes your mortgage. It should go without saying that lowering your cost of living will be a crucial element in this effort as well. (Are you noticing a pattern?)”

Is that even possible any more?

Stop the madness

Even if you haven’t lost your job in this economy, there are enough people who have that you have effectively been forewarned. Debt is NOT your friend, and if you harbor any notions that it is, now is a stellar time to change that view.

Here are steps you can take to get the situation under control if you now have substantial debt:

1. Stop taking on new debt—new debt it not the solution for old debt
2. Cut your living expenses immediately
3. Build up a savings cushion large enough that you can live without credit
4. Once you have a chunk of savings, begin paying down your debt with any system you’re comfortable with
5. If you have debts you can’t pay, contact the lender and attempt to work out a settlement for a reduced payoff; if you have savings, you may be able to get a better settlement with a cash offer.

Once out of debt, stay out of it. If you have to pay for something with a credit card, you can’t afford it. Find a cheaper way. Buy second hand cars and pay cash. If you need financing for college, go to a less expensive school, work your way through and keep any student loans to a bare minimum. Student loans aren’t manna from above, they’re hard debts that will need to be paid back in an uncertain future.

If you buy a house, make the largest down payment possible (20% minimum), keep the term short (15 years) and plan on monthly prepayments to wipe it out sooner. Buy a less expensive home that will enable you to finance under those terms, and if you can’t, you might be better off renting. The practice of perpetual debt has been the undoing of the current housing market.

Save your optimism for your career, your health and your social life, but don’t bet real money that you’ll be able to pay for something over time that you can’t afford now. That thinking has proven to be a sucker bet for too many households right now.

A return to the recent past, or a different kind of future?

For many today, the 1990s are a decade remembered as a time approximating what we might call “normal”, that is, it was a time of economic stability and growth. But often when we think of a time as normal, what we really mean is something more favorable, even desirable, and those were the conditions that prevailed for most of that decade. No one knows whether or not we’ll return to the level of prosperity seen in the 1990s, a decade of low unemployment, low gasoline prices and low interest rates, and what seemed like a certain future. But here’s a clue: the circumstances that produced that gilded decade—the collapse of the Soviet Union and of oil prices in the aftermath of the Gulf War—were events of historic proportions, unlikely to be repeated.

If we’re going to look to the past for clues to the future, we can’t focus our attention on any one time period, especially the more recent ones. The predictable prosperity of the 90s doesn’t in any way invalidate the very different conditions that existed in most of the current decade, or of the 1970s or the Great Depression of the 1930s, another event of historic proportions that molded the spending and savings habits of two generations for decades after.

No one knows what the future holds, so what do we do? Best answer: we err on the side of caution.

What that means, in practical terms, is that we structure our finances on the assumption that the future will see unpleasantness not unlike what’s been experienced in previous times. The idea of taking on debt in that environment—least of all, long term debt—should be something we seek to avoid at all costs. A debt is a fixed cost that will not fall commensurate with a drop in income. For that reason alone, it must be approached with a great deal of caution, especially in times of uncertainty or recognized weakness.

The Payoff: Living without debt

For some, living without debt means living without things that we want that debt can pay for—a form of deprivation in many quarters. But consider a different future, one in which debt doesn’t rule your life…

1. A debt-free position, combined with low living expenses and a healthy bank account balance means you’re beholden to no one.
2. Better sleep and more peace of mind.
3. Not being crushed by a job loss the way it will a more typical household.
4. You’ll still have bills to pay, but you’ll have fewer of them.
5. Less money going to pay monthly debts means more money for savings, a problem for many households even in the best of times.
6. Greater mobility, including the ability to pursue new job and business opportunities that others weighed down by debt can’t consider.
7. A life that’s more people-centered and less money-centered.
8. And finally, an unencumbered mind is a productive mind; absent the worry of debt, the ability to tap your creative energies will be more possible than ever.

What ever the future holds, yours will be more positive in everyway if you aren’t carrying a load of debt along with you.

Is that a future worth working toward?

PART TWO—REFINANCING YOUR CURRENT MORTGAGE AND CONCLUDING THOUGHTS

By Kevin M

Yesterday, in Part One of this series, we took a look at the largely hidden costs of purchasing a new home. Today we’ll take a similar look at the hidden costs of refinancing your current home to determine if doing so is truly in your best long term financial interest.

Refinancing is far less expensive than buying a new home, of course, but the decision to refinance your mortgage to a lower rate isn’t always as clear cut as it seems.

With refinances, people tend to be obsessed with rate. But let me offer that rate alone can be a deceptive metric.

CAVEAT: What I’m proposing here is NOT what you will hear from people in the home lending industry. But please keep in mind that the advice I’m offering is based on a long career in that industry.

The Hidden Costs of Refinancing

Yesterday we listed six costs associated with buying a new home, and while not all of them apply to refinancing, at least two of them most certainly do. Each time you refinance you will incur transaction fees (item 3 on the purchase list), and recast the loan term (item 4). But there are considerations for both that are specific to refinances and warrant additional discussion.

Transaction costs. Transaction costs on refinances generally run 1.5-3.0% of the mortgage amount. This will include most of the costs incurred when you purchased your home, including attorney fees, state or local tax stamps, title charges, lender fees, appraisal, termite and flood cert, etc. In mortgage-speak, it is sometimes said that a refinance is “the borrower buying the house back from himself”—which is totally true in when it comes to closing costs.

On a loan amount of $200,000, the closing costs will run at least $3000 (1.5% of the loan amount) each time you refinance. However, complicating this cost is the fact that many homeowners have refinanced several times over the past 10 years. Refinancing a $200,000 loan three times over a decade will cost you $9000! This is yet another hidden cost of refinancing that few factor into the equation because they think of past refinance costs as dead money. But the question needs to be asked: how many times are you going to pay for the same loan?

Resetting your mortgage term to 30 years. We covered this topic pretty thoroughly yesterday, but an additional consideration in the area of refinances is that there is no limit to the number of times you can refinance and thereby reset the loan term. It’s possible that though you purchased your home 15 years ago, with a 30 year loan, that because of repeated refinancing, you still have something close to 30 years left to pay.

In theory, this can be avoided by lowering the loan term on a new mortgage to the remaining term of the existing one. If you’re five years into your 30 year loan, and wish to refinance, the problem is avoided by reducing the new term to 25 years so that you don’t extend the term of the payoff. In practice however, this seldom happens. Next to rate, the most important consideration on a refi is payment, and most people want that to be as low as possible.

A Factor Unique to Refinancing

Yesterday in discussing the root causes of the current housing and foreclosure crisis, we identified perpetual refinancing, or equity stripping, as a major factor:

Perpetual refinancing. Homeowners tapping and re-tapping the equity in their homes through home equity lines of credit and periodic refinances. As soon as equity is built up, it’s taken out for purposes often unrelated to the house itself, so that the house becomes a source of capital for outside financial activity. The darker term for this process is known as “equity stripping”. Because of this, even people who have owned their homes for many years often have little equity.

Part of the problem of perpetual refinancing is that people have come to view mortgage debt as “good debt”. While that may be true in regard to the portion of the loan that was used to make the original purchase of the home, it does not include the portion that may be comprised of previous or planned debt consolidations, or of equity borrowed out for purposes unrelated to the house.

Debt consolidation is not debt payoff—it merely transfers debt from one form to another. Here’s my experience from my many years in the mortgage industry, one that I’m sure could be shared by anyone with at least a few years in the business…

A homeowner calls to do a refinance on his home, looking to take advantage of the low rates to 1) lower the rate on his first mortgage, 2) roll in a home equity line of credit, and 3) payoff a few credit cards and maybe a car loan.

He manages to get the lower rate, consolidate his debt into one payment and in doing so, to improve his cash flow by several hundred dollars per month. So far, so good.

Two years later, the same homeowner calls to refinance again, only this time he has a new home equity line of credit or a few more credit cards he wants to “get rid of”, meaning consolidating them into a new first mortgage.

The only thing “saving” this homeowner is the fact that his house has been steadily rising in value. He doesn’t ever pay anything off, so his long term debt situation continues to deteriorate even though his cash flow improves with each refinance. The payoff of his mortgage has been moved forever into the future as he now owes far more on his home than he did when he bought it.

The basic problem with this pattern is that it relies entirely upon a perpetually rising value on his home. Absent this, the whole scheme collapses, and that’s where many homeowners are today.

I’d like to say that this scenario is an unusual one, but unfortunately it isn’t.

Comparing Apples to Oranges

At the outset I said that refinancing isn’t all about rate, and here is one of the best illustrations of what I mean.

Oftentimes, the obsession with interest rates and payments can obscure more important considerations. Consider the following example:

A homeowner is five years into a $200,000, 30 year fixed rate loan at 6.00%. Monthly payment is $1199.

Rates have dropped, and the homeowner wishes to replace that loan with a new one, same balance, with a 30 year fixed rate loan at 5.00%. He’s paid the loan down a few thousand dollars over five years, but recasts for the original balance to cover closing costs and escrow allowances. Monthly payment is $1074, a savings of $125 per month—looks good.

But this isn’t a straight up comparison; the homeowner will replace a loan with 25 years remaining with a 30 year loan. Were he to recast the new loan on a 25 year term, the new payment would be $1169, a savings of only $30 per month—hardly worth the effort.

If he were to accept the new loan at 30 years, he would save money on his monthly payment, but he would do so largely by transferring those savings to the back end of the loan. He will continue paying his mortgage for a full five years after the original loan would have been paid off.

When taken in this context, the refinance no longer looks so appealing.

Stay in Your House and Payoff the Mortgage

The point of this analysis of the finer points of both purchasing and refinancing is to emphasize that neither activity may be in your best interest if your ultimate goal is a stronger financial position.

Any time you purchase a house or refinance the one you already own you are incurring costs to do so. Much of the seeming advantage of refinancing and trade-up home buying have been an illusion caused by rising prices. In a static or declining price environment, such as exists in much of the country right now, the real costs of churning your mortgage or your housing situation become more obvious.

But what if you abandon refinancing and trading up?

It isn’t very exciting, but it’ll get you to financial independence faster because you won’t be increasing your carrying costs every few years by increasing the loan balance or moving up to a bigger house. You’ll also be avoiding the transaction costs included every time you buy or refinance.

Let your income grow while your house payment stays relatively level, and eventually nearly disappears, and see what affect that has on your finances. Imagine that the house you bought in your 20s is paid off by the time your in your 50s. No prepayments, just making the scheduled payment every month for 30 years. Very simple, very BORING! But very effective.

What’s the secret? Don’t recast the term, increase the balance or trade up to a larger home.

Just keep doing what you’re doing now. Author Robert Ringer referred to such tactics as “the slow, fast way” to success.

There are times when buying a bigger house makes abundant sense, such as when you have children. But this is where some real soul searching needs to be done. Is the real reason you need a bigger house because your family is growing, or perhaps because of some external factor like a housing mania, the new house bug, or even the desire to impress others?

It’s those external factors that are the real force behind high housing costs. So sit back, relax, and without doing anything extra, you’ll reach financial independence a lot quicker.

PART ONE—BUYING A NEW HOME

By Kevin M

In response to the mortgage meltdown/real estate slump of the past two to three years, the U.S. government has intervened with the take over of FNMA and FHLMC to insure the free flow of mortgage money, interest rates are being held down to the 5% level and an $8000 home buyer credit has been put in place to stimulate activity.

But should you as a homeowner take the bait and either trade up to a new and more expensive home, or perhaps refinance into a lower interest rate loan?

I’m going to take the contrarian’s view and argue against either course.

It should be noted that this series will deal specifically with current homeowners. For all of the reasons stated above, now might be an excellent time to buy your first home.

Since this is a long and involved topic, I’m going to cover it in two segments as it pertains to purchasing a new home and refinancing the mortgage on your current home. Today, we’ll take a look at purchasing, and cover refinancing tomorrow.

A Different Time—and Maybe Even a Different Country!

There was a time, yes, even here in America, when a primary goal of homeowners was the payoff of the mortgage on the family homestead. Many of the current generation of retirees are benefiting from the payoff of their mortgages earlier in life, conditioned as they were to payoff debt as soon as they were able.

Have you ever heard of a “mortgage burning party”? Chances are you haven’t, at least not in a couple of decades, because with our current world of trade-up-or-refinance-every-few-years routine, most mortgage indebtedness just gets recast and expanded again and again, with the end never in sight. A mortgage has come to be viewed as permanent debt.

If you’re truly interested in improving your long-term financial situation, or of ever retiring in some degree of comfort, the payoff of your mortgage should be a practical reality, and not just an oft-stated goal that gets pushed off into the indefinite future. The most fundamental aspect of the mortgage foreclosure crisis is people being too deep in debt!

The Root of the Current Crisis

In the struggle to revive the housing market, it’s worth revisiting the issues that are at the root of the current crisis:

Overbuying. The mantra in the real estate industry is to buy the most house you can afford, and even more if you can. This has been accomplished by the reduction or outright elimination of down payment requirements, the relaxation of income guidelines, the introduction of low teaser rate loans (interest only and adjustable rates) and no income verification programs.

Perpetual refinancing. Homeowners tapping and re-tapping the equity in their homes through home equity lines of credit and periodic refinances. As soon as equity is built up, it’s taken out for purposes often unrelated to the house itself, so that the house becomes a source of capital for outside financial activity, the so-called ATM effect. The darker term for this process is known as “equity stripping”. Because of this, even people who have owned their homes for many years often have little equity.

Overvaluing of property. People like higher values, especially when it concerns what is for most, the largest asset they own. The situation becomes even more pronounced when the housing market is booming, and prices can eventually catch up with expected values. But appraising a property is not an exact science, and the best that can reasonably be produced is a value range. A house might be valued at somewhere between $180,000 and $200,000, with a reasonable placement at the midpoint of $190,000. But in order to make the customer, agent, builder and lender happy, the value will be set at the upper range of $200,000. Or maybe 205. Or even—210—maybe? A house will be sold at that value, or a refinance may be taken based on it, but what that means is that the loan will be based on an optimistic valuation, that is value which may not exist. Unfortunately, in a soft or declining market, the exact opposite comes into play, and now houses are being valued at the lower end of the range. People are now awakening to the fact that they have no equity, or perhaps they are even in a negative equity position. The sudden realization of a negative equity position is a major driver in people walking away from their homes.

To be fair, there are other factors as well, including overbuilding and the declining economy. However both are beyond our ability to control, and it was largely the effects of the three causes outlined above that produced the oversupply of new housing as well as the bad economy.

Is Now a Good Time to Buy a New House?

Rates are low, it’s a buyers market and the people who should know are saying the “bottom is in” and now is the time to make a move; are they right?

Maybe this is good news for the national economy, and certainly for the beleaguered housing industry, but what does it mean for you personally?

In addition to getting a new house, usually a bigger one, here’s what else you’re taking on:

1. A bigger mortgage. Since you’re mainly trading equity from your current home to a new one, the difference in price will mostly be paid for out of the proceeds of a larger mortgage.
2. A higher payment. A bigger mortgage equals a higher monthly payment. A higher property value generally translates into higher real estate taxes and homeowners insurance.
3. Transaction costs. Most people ignore these because either they’re being paid by the seller, builder or lender. Newsflash: no matter how the deck is shuffled, you’re paying the transaction costs! Even if you don’t pay direct at the closing table, you will pay through a higher sale price, or a higher interest rate (if the costs are lender paid).
4. Your mortgage term resets to 30 years. If the remaining term on your current mortgage has 22 years left on it, you will most likely start from square one with a brand new 30 year loan in an effort to keep the new payment at a minimum. If it was ever your intention to payoff your mortgage, you just took an eight year step back. Even if the payment on the new house seems manageable, multiply the monthly payment on a new home X 12 months X the extra eight years you’re taking on with the new loan, and you’ll get an idea as to the back end impact of the transaction on your finances. How might that money impact your retirement?
5. Moving and resettlement costs. Usually ignored in tallying the cost of moving, but these charges are very real. And it isn’t just the cost of hiring movers. There’s also the cost of moving supplies, utility deposits, restaurant food eaten on the fly, and maybe a night (or two, or three) in a hotel.
6. Property customization. You just moved into your new home; is all as you want it to be? Never. There will always be a need for customizations. New carpet, new curtains, the replacement of a piece of furniture that just doesn’t work in the new house, and those pesky repairs that the seller/builder didn’t complete (or reveal) before closing. Even with new construction, there’s no free ride here.

The basic problem with buying a new house every few years is that you never stay in one house long enough to get the mortgage under control. You stay long enough to build up some equity, then sell and move on to a newer, and typically more expensive home, where the whole process begins again—from square one.

But there is one more problem peculiar to this market from the standpoint of an existing homeowener: the same factors that are causing favorable property values on the buy side will work against you in the sale of your own home. You’ll pay less for a new home than you would have two or three years ago, but in all likelihood, you’ll get commeasurably less for yours.

Tomorrow: PART TWO—REFINANCING YOUR CURRENT MORTGAGE AND CONCLUDING THOUGHTS