Why We Can't Take Mortgage Refinances to the Bank Just Yet

It is obvious that mortgage rates are historically favorable to anyone wishing to buy a home or refinance their current mortgage if their intentions are to stay put for at least the next 2-5 years. If you are expecting this wave of mortgage loans to begin hitting the books of the lenders such as Bank of America (BAC), Citigroup (C) and the rest of the banking sector, don't count your chickens just yet. One key element that many of us are overlooking when it comes to refinancing, is home values.

I'm sure most of us understand the principles of how home values are affecting the buying and selling of homes, but are we assuming that anyone who owns a home has the ability to refinance, as long as they can cover closing costs? The answer is, NO, they can't. The last 5-8 years were notorious for a ton of mortgages going through with little to no money down, and therefore, with property values losing anywhere to 10-30% depending on where the property is located, where is the equity?

For example, if you bought a house in 2005 for 250K, and say you put 5% or 13K down, and since then have added another 10K through principle reduction, and your house today appraises at 200K, you are upside down 27K. No bank in America will finance 227K, when the underlying asset is only worth 200K.

So, in order for you to take advantage of lower rates, the homeowner would need to not only come up with 3-4 grand to close, but pony up an additional lump some to make up for the negative equity caused by the drop in value. Who in this debt ridden nation has 20-30 grand laying around, especially with everyone's brokerage account off by 40% or so? You would either have to:

1. take huge losses, which isn't smart to sell near a bottom, or
2. have played the market perfectly, and went to cash sometime early 2008

I would speculate that many will just continue to pay their mortgage at the existing 6.5% (or whatever the existing rate is). The people who NEED to refinance, because of a lost job, ARM adjustment, etc. definitely will not be able to.

So, until home values hit a bottom, and the illiquid housing market takes a turn for the better, I don't foresee there being this wave of refinancing that so many are expecting. We saw huge defaults on mortgages due to falling home prices, illiquid market, and ARM adjustments. What if you throw 8-10% unemployment in there? I would advise extreme caution if you are thinking of diving back into the banking sector, because low mortgage rates don't always translate into mass amounts of home loans. We are starting to see an increase in applications, but the number of those that actually come to fruition may be another story.

Disclosure: no position in any of the stocks mentioned above

Comments

[Jay:]

I don't think the primary intent of the government's effort was to re-encourage the "house as an ATM" phenomenon, but to help speed the search for the bottom in the housing market.

Also, you're paying down the "principal," not "principle," of the mortgage balance.

Jan 10 11:10 AM

[drc32:]

This is absolutely correct. The people that qualify for refinances are most likely people who were already responsible with their money in the first place. People who need refinances the most are the ones who went 100% LTV on their homes and are living paycheck to paycheck.

Even if somehow they have the equity to refinance, they will not qualify because they've been carrying high-balance debt that has driven their FICO scores down over the last 6 months to 1 year. Don't forget that the banks don't want a repeat of the subprime meltdown so they are not going to lend to these people even though they would have 2 years ago.

Jan 11 12:25 PM

[futurestrader:]

Jay, I don't believe I mentioned in the article anything about "house as an ATM". I was mainly bringing attention to the fact that low historical interest rates don't always correlate to a wave of refinances. An increase in mortgage applications doesn't hold any water, and might not help remove some of the toxic mortgages out there like so many believe. This article also makes note that home values play a vital role in this process as well, just like you are pointing out. You may want to read again and try and digest what I am trying to say. I really appreciate your knowledge though in regards to correcting my mistake with the heterographic homophone. I forgot that this was an english blog and not a financial blog. Do you live in a glass house?

Jan 15 12:08 PM