CHAPTER 9
Refinancing and Home Equity Loans
A refinance is just that, “redoing” the original mortgage. There are different reasons to refinance, including to get a different rate or different term, or to replace a current loan with a new one and pull money out at the same time to do with whatever you wish.
9.1 WHY WOULD I WANT TO REFINANCE MY MORTGAGE?
There are many reasons, but the primary one is to reduce the interest rate on your current mortgage loan. If your rate is at 8 percent and current rates are at 7 percent, then you might consider refinancing to get a lower payment. It really doesn’t make much sense to refinance if rates go up, right? But lowering a monthly payment may make sense to you if you can save money on mortgage interest. Refinancing to get a new rate is called a rate-and-term refinance. You’re changing the interest rate, and changing the term, or length, of the new note.
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Let’s say you bought a home a few years ago and borrowed $200,000 when the interest rates were 5.5 percent. With a 30-year fixed-rate mortgage, that payment would be $1,304. Later, mortgage rates dropped to 4.375 percent, which would give you a new monthly payment of $1,206, saving you $98 per month. That’s a fairly hefty difference. Taken out to full term, that’s a savings of over $35,280 in mortgage interest, while at the same time freeing up $98 each and every month.
Another reason to refinance might be to go from an adjustable-rate mortgage to a fixed-rate mortgage to remove the uncertainty that adjustable-rate mortgages carry. Yet another reason might be to get a hybrid loan or an ARM when fixed rates are relatively high. If mortgage rates seem to be at a peak and there’s not a whole lot out there under 8 percent, some borrowers take an ARM that has a lower start rate. Instead of an 8 percent fixed, say a borrower elects to take a 6 percent 3/1 ARM. A couple years later, rates begin to move down and fixed rates hit 6 percent, the same rate as the hybrid. At that point, it would be wise for the borrower to try to get out of an adjustable rate and move into a fixed one.
That strategy can also work in reverse. Some people want to get the lowest payment possible on their loan, regardless of whether it’s fixed or adjustable. You can always move from a fixed to an ARM. Still another reason to refinance might be to pull some equity out of your home in the form of cash while at the same time bringing down your overall interest rate.
9.2 SHOULD I WAIT UNTIL THE INTEREST RATE IS 2 PERCENT LOWER THAN MY CURRENT ONE TO REFINANCE?
No, and I’ll explain why. The real test is how long it takes to recover your closing costs using your new lower payment, compared to how long you anticipate keeping the house. Forget all the so-called rules of thumb.
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Subtract the new lower monthly payment from your old payment, then divide the closing costs of your new loan by that difference. The result is the number of months required to “recover” the closing costs paid. For instance, if your savings are $150 per month and your closing costs add up to $1,500, then it would take 10 months to recover the fees associated with the new loan. If you plan on owning the home more than 10 months, then you might want to consider a refinance. That’s about it. It’s not rocket science.
If you decide to wait until rates drop another 1/2 percent to get to the magic “two years” date, you may be waiting for two more things: lost interest savings because you didn’t refinance sooner and the possibility that rates will turn back up!
On the flip side, say you refinanced and saved $150 per month. However, you immediately got transferred and had to sell your home, which means that you would never recover those closing costs, much less enjoy lower payments on that house. The key to a refinance is saving mortgage interest while keeping an eye on closing costs, and at the same time anticipating how long you’ll own the house.
9.3 WHAT IS MY RESCISSION PERIOD?
A rescission period is a unique feature of refinanced mortgages and only applies to your primary residence. It’s a three-day grace period that lets you out of your mortgage agreement with no strings attached.
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When you first bought your home and closed your loan, your lender funded that loan the very same day. There was no “buyer’s remorse” period. If, however, you later refinanced that home, your primary residence, the loan didn’t fund that day. Instead, there was a mandatory three-day “cooling off” period to allow you time to reconsider your actions. Those three days start the following day and end the third day. Your loan would fund after the third day. Please note that those three days must fall between Monday and Saturday. Note that Sundays and holidays don’t count. Why is there a rescission period? It gives you time to evaluate your loan and review your papers and closing fees. If there is a problem, you simply sign your rescission papers and the whole deal’s off.
If you refinance your mortgage, go to closing, and find that the interest rate wasn’t what you were quoted and the loan officer won’t change the papers, then you have three days after that to decide whether you want the loan. Are closing costs much more than you anticipated? You have three days to decide if you still want the deal.
For that matter, you can change your mind for absolutely any reason, or for no reason at all. You can rescind simply because the wind changed direction. Be warned, however, that if you decide to rescind, you’re not going to get some of your fees back that you already paid. The deal simply falls through and everybody goes home.
9.4 HOW LONG SHOULD I WAIT TO RECOVER CLOSING COSTS?
That’s a fair question. If you applied the refinance test solely to owning the home longer than it takes to recover the fees, then it might get a little stupid if your recovery time is 10 years. So what’s a good period? I think anything less than two years to recover fees is a good test, but your personal mileage may vary. Anything longer than two years and you could have done better by investing a couple of thousand dollars somewhere or simply paying down your principal balance. We’ll look at ways to save on your closing costs in Chapter 14.
Several states, in response to predatory lending legislation, have set certain standards whereby a person can refinance a mortgage without having it labeled a “predatory loan.” Some states employ a test called Reasonable and Tangible Net Benefit (RTNB). This is a requirement that the consumer understands that there will be a real benefit to refinancing a mortgage loan. There is a form to be completed by you that asks several questions, such as, “Are you reducing your interest rate by 2 percent?” or “Are you reducing your loan term?”
When legislators make a law, lenders have to devise their own strategy as to how to comply with that law. Some lenders will use different methods to make sure they’re making legal loans, but most require that the borrower and the loan officer sign a piece of paper stating, “Yes, I have a good reason to refinance,” and explaining why, and then they move on. I realize it sounds a little strange to have to explain why you’re refinancing, but there are some bad people in the world, and it’s those bad people who mess things up for everybody.
9.5 DO I HAVE TO CLOSE MY LOAN WITHIN 30 DAYS, OR CAN I WAIT TO SEE IF RATES DROP FURTHER?
No, you can close a refinance anytime you want. I’ve had clients in process for months before they decided to take the plunge and refinance to a lower rate. When rates begin to drop, it’s tempting to squeeze out one more week to see if rates drop further. It can be disappointing to close your loan at 5 percent when three weeks later, rates drop to 4.75 percent. But no one can tell the future, and sometimes waiting too long can actually damage your effort.
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Let’s say that your payment on an 8 percent 30-year $200,000 mortgage is $1,467. Of this amount, only about $140 goes to principal reduction while the rest is all mortgage interest. Meanwhile, rates are at 7 percent and you’re deciding whether to refinance now or wait and see if rates drop even more. A 7 percent rate drops your payment to $1,330, or a savings of $137. But you’re waiting to see if you can get below 7 percent—say, 6.875 percent, which would drop your payment down by another $17 to $1,313. So instead of taking the 7 percent and the $137 reduction, you wait another month for rates to drop further still.
And you wait a little longer. And a little longer. So far, three months have passed and rates still haven’t gone below 7 percent. If you had refinanced to 7 percent, you would have saved $411 already, but by waiting you essentially lost that savings, costing you $408. And what about that $17 per month savings at 6.875 percent? Divide that $17 into $411 and that’s how long it will take to recover what you lost by waiting. That’s 24 months.
9.6 WHY ARE THERE FEES ON A REFINANCE?
A refinance is a brand-new mortgage, that’s why. You will have new title insurance, a new note, a new lien, a new everything, mostly. Yes, you might have an appraisal that’s three years old, but lenders want to see an appraisal showing more recent sales. You’ll also need a new credit report for the same reason. Lots can happen to a credit report over just a few months’ time. But to make a mortgage loan eligible to be sold in the secondary markets, it will have to be handled the same as if it were a brand-new purchase loan.
One welcome difference in a refinance is that you can roll your closing costs into your loan balance instead of paying for them out of pocket as you did when you bought the house. But there are ways to reduce those fees or eliminate them altogether when you refinance.
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One way is to let your lender pay those closing costs for you. This is called a no-fee loan. If you agree to a slightly higher interest rate, then the lender might pay your closing costs for you. Usually you’ll get a 1/4 percent change in rate for each one discount point. One discount point is equal to 1 percent of your loan amount; so by increasing an interest rate from 4 percent to 4.25 percent, you could save $2,000 in closing costs on a $200,000 mortgage. Your lender will happily offer a higher interest rate and you will happily reduce your monthly payment essentially free of charge. The difference in a quarter of a percent on a $200,000 30-year fixed-rate loan? About 22 bucks. Your monthly payment will be a little higher on a no-fee loan, but the difference is marginal compared to the amount of closing costs associated with the lower rate.
Note that there is really no such thing as no-closing, or no-fee, or zero-closing-cost loans. In fact, that’s really a dubious claim, and with good reason: There are closing costs! Instead of your paying them at closing, they’re buried in your new, higher rate. You pay every month.
9.7 SHOULD I PAY POINTS FOR A REFINANCE?
I’ve never been a big fan of paying discount points and origination charges on any loan, purchase or otherwise. If you paid a discount point one year ago to get a better rate and now rates are even lower, that discount point is essentially lost, isn’t it? Yes, you may have gotten an income tax deduction from the point, but it didn’t really help you out in the long run, did it? Especially in light of what interest rate cycles look like at the time you buy your home. When you bought your house, there were closing fees involved, and if you refinance, there will also be closing fees involved unless you choose a no-fee loan. However, it pays to look at recent interest rate trends to see if you’re at the top of an interest rate market or at the bottom of one.
If rates are at historic or near-historic lows and you intend to keep the property for several years, then you might want to pay a point or two to get the absolute lowest rate on the planet. If interest rates are not at historic lows, you may be hard pressed to make a case to pay extra fees just for a lower rate you might not have for very long. If you paid one point to get a 7 percent rate instead of a no-point 7.25 percent rate, on a 30-year fixed-rate mortgage for $100,000, the difference in payment is $16 per month. Over the life of a 30-year loan, that’s over $5,700 in interest. But if interest rates drop over the next couple of years to 6 percent, then you won’t see the long-term benefit of paying the additional point in exchange for the lower rate. What if you took that same thousand dollars and invested it in a guaranteed instrument, like a tax-free bond or note? Better yet, if instead of using the $1,000 for a discount point you used it to pay down your principal at closing, you’d save over $7,000 in interest over the life of the loan.
Interest rates go in cycles, and they’ll typically cover a three-to five-year period. If you buy a home or refinance one at or near high interest rates, choose a no-fee loan. This way, if rates do indeed drop in two or three years, it’s less costly in the long term. So forget about the “rules of thumb.” Look at your particular situation to see if it makes sense.
9.8 WHAT ABOUT REDUCING MY INTEREST RATE AND ALSO REDUCING MY LOAN TERM?
Changing your loan term along with your rate may also be a good reason to refinance your mortgage from a 30-year to a 15-year loan. In fact, this is one of the most common reasons people decide to refinance in the first place. For instance, let’s say you have a 30-year mortgage at 8 percent with a $125,000 loan and you’ve been paying on it for a couple of years. Soon, interest rates drop to 6.5 percent for the same 30-year fixed rate loan, but you also see that 15-year loan rates are in the 5.75 percent range. While the monthly payment for a 15-year loan will actually increase from $917 to $1,038 per month, it’s not a huge difference, especially when compared to how much interest is being saved by switching loan terms. That 30-year rate of 8 percent costs $205,000 in interest over the life of the loan while the 15-year rate has just $61,800 in interest charges. That’s a heckuva difference and something to consider instead of just thinking about lowering your monthly payment.
Another advantage of loans with shorter terms is that they let borrowers get rid of their debt quicker. Are you retiring in 20 years? Fifteen years? Do you still want to be making house payments in your golden years, or do you want to own your home free and clear? Choosing your loan term is something that should be an integral part of your retirement plans.
9.9 WHY NOT JUST PAY EXTRA EACH MONTH INSTEAD OF REFINANCING?
You can. For some people, paying the same amount each month, every month, is a little more “automatic.” Payment by payment, more money goes to principal rather than to interest. I had a client who refinanced his mortgage from a 30-year to a 15-year for a very specific reason: his daughter. Why? He knew his daughter was going to be starting college in 15 years and he didn’t want any house payments at that time. He also knew that while he sometimes paid a little extra on his note each month, he didn’t have the discipline to make those additional payments month in and month out. So instead he chose a 15-year loan, and when his daughter goes to school he’ll be mortgage-free.
9.10 WHAT’S A CASH-OUT MORTGAGE?
A cash-out refinance is the exact same process as a refinance, only this time you come away from the closing table with a check in your hand, taken from the equity in your home. For instance, you refinance your 8 percent rate on a $125,000 loan to 6.75 percent. But instead of refinancing $125,000 you obtain a new loan of $150,000, giving you $25,000 extra to do with what you please. Not a bad deal, right? Yes, it’s not bad, but there are some things you must pay attention to, otherwise you might make some critical mistakes. The first mistake often made is the amount requested compared to the value of your home.
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If you recall, your first mortgage needs to be at 80 percent of the appraised value of the home or you’ll need private mortgage insurance. This requirement doesn’t change when it comes to refinancing your note, either. While you can finance more than 80 percent of the value of the home—up to 90 percent, in most cases, while taking cash out—you’ll have more than just a PMI premium. Your interest rate will increase slightly as well. In fact, if you take cash out while refinancing and your loan accounts for more than 75 percent of the home’s value, you might also find you have to pay a 1/4 point fee to do so. No PMI, but a 1/4 point fee.
It sounds like a no-brainer, but I’ll mention it anyway: If your home is valued at $100,000 and you’re taking cash out, a $76,000 loan (76 percent loan-to-value, or LTV) will cost you an additional $250 compared to a 75 percent LTV loan that carries no additional fee for cash-out. Why this “bump” for cash-out loans? Lenders have found that home loans with cash-out have a higher default rate.
Be careful about pulling out cash. Some loan officers can look up old loan files that they’ve closed before, call you up, and tell you how much money you’d save each month if you paid off your two car payments and credit cards. The math always works, but don’t refinance just to pay off other debt besides your mortgage. Why?
Let’s say you have two car payments of $400 each, with a $10,000 balance on each auto loan. Now add some credit card balances you want to pay off totaling $10,000. So you’ll need to add $30,000 to your new loan. If you add $30,000 to your loan under the new lower mortgage rate of 7 percent, suddenly that $1,000 in automobile and credit card payments is reduced to $199. A loan officer can make a pretty good case for this transaction. Who wouldn’t want to save $800 per month?
Remember, though, that you’re now amortizing that $30,000 over 30 years, and at 7 percent you’d pay over $41,000 in interest, much of it in the early stages of your newly refinanced mortgage. Refinancing and pulling cash out can be advantageous to your cash flow and can make lots of sense, but don’t do a cash-out unless it really makes sense to you and not just to your loan officer.
9.11 HOW DO I GET MONEY OUT OF MY PROPERTY WITHOUT REFINANCING?
You can do a couple of things, actually. And they’re fairly easy. The first is to get an equity second mortgage on your house for almost any amount you’d like, up to the standard loan-to-value guidelines. The second is to get a home equity line of credit.
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Most cash-out second mortgages let you borrow up to 90 percent of the total loan-to-value (TLTV) and carry little, if any, closing fees. Some direct lenders don’t charge anything for a second mortgage, while others do. Still other title agencies and settlement companies charge a fee for a second mortgage, but they’re marginal when compared to fees associated with refinancing a first mortgage loan. Expect no more than a couple hundred dollars in fees, if that.
Most equity seconds (i.e., home equity second mortgages) are in fixed-rate terms, with the most common being the 15-year fixed-rate note. There are other options, such as a 20-year note, and you might even find a 30-year loan out there, although they’re not as common. In fact, most of the equity seconds that allow for a 30-year amortization (which reduces the payment) balloon after 15 years. These loans are called 30 due in 15, or 30/15. You make payments amortized over 30 years but the loan will come due in year 15.
Another popular option is called a home equity line of credit (HELOC). A HELOC is similar to a credit card in that you’re given a limit on how much you can borrow. Whether you borrow the full amount right away is up to you. Typically you’re simply given a credit line and you write a check against it when you need it. Usually HELOCs are adjustable-rate loans; in fact, I’m not sure if I’ve ever seen a fixed-rate HELOC, because the interest rate is set when a balance is actually drawn. And the most common index for HELOCs is the prime rate plus a margin, with margins being anywhere from 0 to 3, depending upon the credit grade of the borrower.
Want a neat trick on using a HELOC to help buy a home? Actually it’s not to help you buy the home, it’s to help what you do immediately after you buy your home. Let’s say you find a house that’s selling for $200,000 and you want to put 20 percent down to avoid PMI and to keep your mortgage payment low. But you also are a little skittish about putting all your hard-earned money into a house, leaving your financial cupboards bare, so to speak. Banks can issue a HELOC right after closing, giving you access to a new line of credit on your house, and if you want to replace some of your down payment money you can make a withdrawal on your HELOC. Deposit institutions such as banks, savings and loans (S&Ls), and credit unions typically issue HELOCs, so you won’t find this option at a mortgage banker or mortgage broker.
But you also don’t have to get your mortgage from a bank or credit union to get a HELOC; you can get your mortgage anywhere and still get one of these loan programs. Certain lenders and certain states may regulate how big your credit line may be or how much you can borrow, so check with your local lending laws and guidelines. But all in all, HELOCs can be a handy financial tool.
9.12 HOW DO I REFINANCE IF I HAVE BOTH A FIRST AND A SECOND MORTGAGE?
Good question. There are some very important considerations here when refinancing a mortgage that has subordinate (second) money behind it. First, given enough equity, many people are simply rolling their first and second mortgage into one. Most second mortgage interest rates are higher than those for first mortgages, which lowers the overall monthly payment.
But the surprise for those who carry second mortgage balances is caused by recent changes in lending guidelines. If you had just one mortgage when you bought your property but later on got another loan—be it a home improvement loan or a HELOC—lenders assign this second loan “cash-out status.” Because cash-out loans carry a higher default rate than non-cash-out loans, you could be in for a surprise. If both your loans together total more than 75 percent of the appraised value of the home, you might very well see a slightly higher rate or a fee.
9.13 WHICH IS BETTER, A CASH-OUT REFINANCE OR A HELOC?
If all you’re wanting is to have access to some of the equity in your home, then take the HELOC. They’re inexpensive (sometimes free) and quicker to get. A refinance cash-out loan carries closing costs just as a standard refinance does, so only do a cash-out if you’re simultaneously refinancing for other legitimate purposes such as lowering your current interest rate, going from an ARM to a fixed, or changing loan terms.
9.14 WHY IS MY LOAN PAYOFF HIGHER THAN MY PRINCIPAL BALANCE?
Because the lender is adding mortgage interest that you’ve yet to pay your current lender. When you refinance your mortgage, your new loan officer will order a final payoff from your old lender. This is your current principal balance, which will be showing up on your credit report, plus unpaid interest.
Mortgage interest is paid in arrears, or backward. Unlike rent, where you pay for the upcoming month, mortgage interest accrues daily until you finally make your payment on the first of the following month. Your July 1 payment is for interest that added up every day in June. When your lender gets a payoff and you’re scheduled to close on the 20th of the month, your payoff will be your principal balance, plus accrued interest to the 20th, plus interest for your three-day rescission period.
You will also see another interest charge: prepaid interest. This is the daily interest rate that takes you up to the first of the following month. In this example, you would have seven days of prepaid interest added to your loan. Because you make a prepaid interest payment when you go to a loan closing, you will “skip” your first month’s house payment. Well, not really skip it altogether; it’s just that you paid it ahead of time in the form of prepaid interest at closing. It just feels like you’re skipping it. Some lenders advertise that you can refinance a mortgage loan and “skip” two or three payments. Don’t fall for it. Lenders don’t let you skip payments; instead the interest is rolled into your new loan balance.
9.15 MY CREDIT HAS BEEN DAMAGED SINCE I BOUGHT THE HOUSE. WILL THAT HURT ME?
Maybe. You’ll have to qualify all over again, just as when you bought the home, so if you’ve experienced some credit problems, such as collections, late payments, or even bankruptcy, you may not be able to refinance your mortgage due to the bad credit. If you have a healthy equity position due to values increasing in your area, or perhaps you’ve paid extra on your mortgage many times, your better equity can offset negative credit. Again, just because you think you won’t qualify due to bad credit, don’t let it stop you from going ahead and applying. If you don’t apply you’ll have no opportunity at all to get a lower rate, right? But just because you qualified when you first got the mortgage doesn’t necessarily mean you’ll qualify with a refinance.
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Let’s say that you applied for a refinance and got turned down. Something happened since you got your first mortgage, and the new lower payment you’re applying for has nothing to do with what you’re paying now. It has everything to do with looking at your application as a brand-new loan. Which it is, right? If this is your case, then you may not have much of a choice and instead must simply sit this one out. That is, if you have a conventional mortgage. If you’ve had bad credit but have a government mortgage, such as a VA or FHA loan, you’re in luck.
FHA and VA loans both have a refinance feature that basically doesn’t care what the credit looks like as long as you’ve made your house payments on time and you’re reducing your mortgage interest rate. FHA calls it a streamline loan and VA calls it an interest rate reduction loan (IRRL). Leave it to the government to come up with the weird acronyms. Both programs operate in a similar way when it comes to refinancing and credit issues.
One important thing to remember with an FHA loan when refinancing is to always close at the end of the month. Why? When a lender pays off your old FHA mortgage, interest is automatically added to your outstanding loan balance up to the first of the following month. If you close your refinance on the fifth of the month, your new loan will contain additional interest all the way up to the first of the next month, even though you didn’t have the loan to the end of the month. You have to pay a full month’s mortgage interest regardless of when you close an FHA refinance, so to avoid unnecessary interest, close at the end of the month.
9.16 HOW DO I GET A NOTE MODIFICATION?
A note modification is taking the original terms of the note and reducing the interest for the remaining term of the loan, without changing any other part of the obligation or title. A note modification therefore means you can’t “shop around” for the best rate to reduce your payment; instead, you must work with your original lender who still services your mortgage. In a modification, nothing can change except the rate. How do you get your note modified? You ask.
You won’t go directly to your old loan officer, but you’ll most likely end up with the lender’s servicing department. Plus, you won’t get the best rate on the planet, either. Your lender knows that it will cost you to get another mortgage in terms of fees, but even though you may not get the best interest rate available, you’ll get one that’s in the same ballpark. Not all lenders modify their notes. They don’t have to if they don’t want to, and some simply don’t want to. But before you begin the sometimes-arduous task of refinancing your loan, contact your lender and see if they will modify your note and, if so, at what rate.
Loan modifications have become more common since 2008 with various programs introduced such as the HAMP loan described in Chapter 7.
9.17 WHAT IS A “RECAST” OF MY MORTGAGE?
A recast applies to ARMs and is used when extra payments are made to the principal balance. When you make a regular payment on your adjustable-rate mortgage, the payment is calculated each time your adjustment period arrives. Your remaining principal balance is calculated along with your remaining term and new interest rate. This happens naturally as fully amortized ARMs come up for their annual recalculation. Your note is “recast” and your monthly payment is calculated for you.
Let’s say that you get a windfall one month and win $10,000 in the lottery. I know, you’re thinking, “Yeah, right,” but hang with me here. Instead of buying 10,000 more lotto tickets you decide to pay down your mortgage balance. Now, your new payment will be calculated using your new loan balance and mortgage terms. When you recast with an ARM, your payments will drop, assuming your interest rate doesn’t go up to offset the decrease in loan amount. Prepaying an ARM works differently from prepaying a fixed-rate mortgage. When you prepay a fixed-rate mortgage, your payment doesn’t change, it just reduces the term. When you pay extra on an ARM, your payment drops.
9.18 WHAT HAPPENS WHEN MY LOAN IS SOLD?
Nothing, really, except that you’ll be sending your mortgage payment to another lender. Lenders can make money by collecting monthly interest payments, or they can sell your loan to another lender. If you have a $100,000 mortgage and a monthly payment of $650, then your lender makes about $600 every month for the first year or two of the loan. That’s not bad, but a loan taken to a term of 30 years also packs about $224,000 in interest. Sometimes, instead of waiting for a loan to come to term to collect all that money, a lender might decide to sell that loan.
Why do lenders sell loans? That depends upon what their current financial strategy is. If lenders want to make more mortgage loans, they need to go find more money. They can do that by selling their loans. Sometimes they sell them one by one, called “flow,” and other times they package them all together and sell them as a group, called “bulk.” What’s the sense in selling a mortgage just to make another one? Good question.
Mortgage rates change. And some loans that lenders have lying around in their vaults might have lower interest rates than what’s currently available on the market. If the lender has a bunch of loans yielding 5 percent and rates are at 7 percent, they’re losing money by not making new loans. But they need new money to make new loans, so they sell the old ones. Now, why would a lender buy loans at interest rates that are lower than the market?
Again, lenders can have different strategies. There’s a lot to be said for having guaranteed rates of return at 5 percent rather than risking some or all of that to try to make more loans to more people. Selling loans to make more loans carries some risk. At other times, lenders make agreements to buy and sell from one another at preset prices, way before a loan is closed.
More important than the question of “why” lenders buy and sell loans is the impact it has on a consumer. Your note and the terms of your agreement will never change. When your loan is sold, your new lender can’t call you up and tell you they’re raising your interest rate or they want to call in your loan. Mortgages can’t be changed when the loan is sold. For the consumer, there is only a temporary inconvenience. You may find that it’s a slight pain to have to write a check to the new lender, or you may worry whether your last payment got credited or your new payment made it on time.
Lenders send out “hello” and “goodbye” letters, typically 45 to 60 days in advance of your loan sale. The goodbye letter is from your soon-to-be-old lender, telling you who the new lender is and explaining your rights as a consumer. The hello letter is from your new lender, giving you your new coupon book or mortgage statement. But other than a little paperwork, selling your note changes nothing.
9.19 WHAT’S A REVERSE MORTGAGE?
A reverse mortgage is designed to help older Americans who own their homes by paying the homeowner cash in exchange for the equity in their home. Many times the elderly are “house rich” but “cash poor,” and they need a way to tap into the equity in their home to help pay the bills or pay for a trip or practically anything their heart desires. When the homeowner no longer owns the home by selling or moving out or dying, then the reverse mortgage lender is paid back all the money borrowed plus interest.
9.20 WHO QUALIFIES FOR A REVERSE MORTGAGE?
Anyone who owns their home, lives in it, and is age 62 or older can qualify. There are no credit or income qualifications for a reverse mortgage, but the lender must determine you have the ability to pay the property taxes, insurance, and maintenance. You don’t sell the property to the reverse mortgage lender, either. Ownership never changes hands and you always retain title. The reverse mortgage lender simply does not own the home, a prospect that could scare some people into thinking that a reverse mortgage would be a last resort when trying to figure out how to pay for retirement or other financial needs in their golden years. Simply put, the lender can never “foreclose” on the property.
9.21 HOW MUCH CAN I GET WITH A REVERSE MORTGAGE?
That depends upon a few things, but reverse mortgages are primarily calculated based on the age of the borrower (loan-to-value numbers are triggered by life expectancy), the market value of your home as determined by an appraisal, and any other liens on the property. Typically, the bottom line is that the more equity you have in your home, the larger amount you’ll be eligible for. For a home that has $200,000 available equity and where the borrower is 75 years old, the approximate loan amount would be just over $100,000.
One of the biggest differences between a reverse mortgage and a cash-out refinance is that it’s a safer vehicle in which to borrow money. With a cash-out refinance, when the payments aren’t made, the lender can foreclose and grandma loses her house. With a reverse mortgage, that can never happen. Reverse mortgages require some counseling, so find a loan officer to help you sort out the details and decide how and when you’d like to have your funds sent to you.
9.22 WHY NOT DO A CASH-OUT REFINANCE INSTEAD OF A REVERSE MORTGAGE?
Because a cash-out refinance requires the homeowner to make monthly payments back to the lender, which sort of defeats the purpose. Furthermore, reverse mortgage funds are tax-free. With a reverse mortgage, the lender agrees to pay the homeowner a certain amount of money either in a lump sum or in installment payments in exchange for equity in their home. The homeowner doesn’t have to qualify for the mortgage from a credit or income perspective, but does need to be at least 62 years of age. The homeowner never has to pay it back and doesn’t “sell” the home to the reverse mortgage lender. The lender gets their loan back when the property is sold after the homeowner dies or when the homeowner moves to a different house. All loan proceeds due the lender get satisfied at that time, not before.
That’s what makes reverse mortgage lending “odd”—it’s certainly a mortgage but doesn’t act like one. Since there are no payments made from the homeowner, there’s no such thing as a foreclosure or delinquency, and title doesn’t change hands. The homeowner doesn’t sell the property to the lender; it’s simply an advance on the equity of the home, plus interest. There are closing costs involved, and those costs are going to be somewhat higher than for a conventional loan, primarily due to the mortgage insurance premium required for all reverse mortgages. But just as with a conventional refinance, you can include those with your mortgage. You need to sit down with a reverse mortgage loan officer who will detail the plans available to you and answer any questions you may have.
9.23 ARE THE CLOSING COSTS FOR A REVERSE MORTGAGE THE SAME AS WITH A REGULAR MORTGAGE?
Many of the closing costs for a reverse mortgage are similar to a refinance, and you’ll need title insurance and a survey and escrow charges and so on. The difference is that closing costs are deducted from reverse mortgage proceeds instead of your writing a check for them. The only thing you might pay for out of pocket is your appraisal, which runs around $350 or so. But closing costs on reverse mortgages can be expensive. There is also a monthly servicing fee for reverse mortgages, called a “set aside,” which is used to help cover monthly servicing. It usually costs about $30 a month or so and is deducted from your loan proceeds, based upon how long the lender assumes the reverse mortgage loan will be in place.
The primary reverse mortgage today is one from FHA called the Home Equity Conversion Mortgage, or HECM (pronounced “heck-um”). FHA also has a mortgage insurance premium equal to 2 percent of the reverse loan amount plus a monthly or annual fee equal to 1/2 percent of the reverse mortgage balance, similar to any other FHA loan. Mortgage insurance is probably the single biggest closing cost with a reverse mortgage. It is not the type of mortgage insurance that pays off a lender if someone dies, but in this case it is used to guarantee that you will always have access to your funds if your reverse mortgage lender goes out of business.
9.24 WHAT ARE THE RATES FOR REVERSE MORTGAGES?
Lenders can set their own rate programs, but most reverse mortgage loans are ARMs based upon a common index, such as a treasury or LIBOR note, plus a standard margin. If you take one big lump sum, interest at those rates begin to accrue immediately. If you take out funds bit by bit from a reverse mortgage HELOC, then interest only accrues on the money withdrawn and not on your available funds.
9.25 I HAVE A CURRENT MORTGAGE ON MY HOUSE. DO I GET TO KEEP THAT?
No, a reverse mortgage will first pay off any current mortgages on the property, and then you’ll be left with your reverse mortgage funds. If you have a large mortgage compared to your appraised value—say, something approaching 70 percent of the value of your home—you may not qualify for a reverse mortgage purely because you lack sufficient equity.
9.26 HOW DO I KNOW IF A REVERSE MORTGAGE IS RIGHT FOR ME?
Reverse mortgages require counseling that has been prescreened and presented to you in a formal manner. Reverse mortgage loan officers must also go through training and screening to make sure they’re giving you the proper information.
One of the best resources for reverse mortgage information is at the website of the American Association of Retired People, www.aarp.org. Ask plenty of questions and make sure you know exactly what you’re getting into, but if you need or want to access your home’s equity without incurring a brand-new debt along with its monthly payment, then explore a reverse.