Background: Prior to this home-buyers were not eligible to apply for a cash-out refinance inside the first 6 months of owning a home.  This was often problematic for home-buyers who were in the position to buy a home using all cash because the IRS  requires that “Acquisition Indebtedness“, which is basically the amount of mortgage for which a home-owner can deduct the interest on, be set up within the first 90 days of owning the home.  Therefore, a home-buyer had to weigh the option of a) buying a home with cash and subsequently negotiating a better deal on the property versus b) taking out a mortgage so that they could deduct the interest and not positioning themselves as a cash-buyer.

Solution: In 2011, Fannie Mae tweaked the guidelines regarding cash-out refinance eligibility to allow home-owners who buy a home using all cash to conduct a cash-out refinance as soon as they own the home.  There are a few details that home-buyers should take into consideration:

• The program is available on homes that are used for primary residence (up to 85% loan-to-value), second home (up to 75% loan-to-value), or investment property (up to 75% loan-to-value).
• The home purchase must have been an arms length transaction.
• The home purchase must have been made with all cash.  NO MORTGAGE OR SELLER-CARRIED CONTRACT CAN SHOW UP ON THE FINAL HUD-1 SETTLEMENT STATEMENT.
• The underwriter will require that the applicant provide proof of purchase funds to make sure the applicant did not borrow the money from another source.
• Keep in mind that the new loan will be a “cash-out” refinance and not a “purchase” transaction so depending on the occupancy and loan-to-value the rates will likely be .125%-.375% higher.

Who can benefit?: Anyone who has enough liquid cash to buy a home with cash stands to benefit from this new flexibility.  I believe this new provision is especially attractive for real estate investors who are in a position to buy property with cash.  This allows them to negotiate the lowest possible price on a home, replenish their cash so that they can position themselves to buy another property, and get the benefit of deducting the mortgage interest against  rental income.

Baby boomers who are close to retirement may also stand to benefit.  Many have significant retirement nest eggs saved up and are viewing the current housing market as an opportunity to relocate into their dream home where they’ll spend their golden years.

Those interested in pursuing this program are encouraged to contact their mortgage professional BEFORE buying a home so they can be pre-approved for the cash-out refinance prior to closing.

“…homeowners will need to determine their closing costs and monthly savings. Divide closing costs by savings; that tells you how many months it will take to break even. If you plan to stay put that long, a refinance might work.”

However, I take issue with this simplistic approach because it doesn’t take into account the character of the monthly savings.  For example, if a homeowner is 10 years into a 30-year mortgage and decides to refinance into a new 30-year mortgage they will experience monthly payment savings just from the fact that they’d be stretching out their existing mortgage over 30 years instead of the remaining 20.  Monthly cash-flow savings does not necessarily represent “savings” just like transferring money from your savings account into your checking account doesn’t represent “income”.  If it did then everyone would have an interest-only mortgage.

Here’s an example, let’s assume a homeowner took a $300,000 30-year fixed rate mortgage out 10 years ago at 5.00%.  Their monthly principal and interest payment is $1,610 and they have $246,484 remaining on the loan.  Let’s assume that they call a local lender to inquire about a refinance and the lender offers them a new 30-year fixed rate mortgage at 4.75% in the amount of $246,500.  Under this loan their new monthly payment would be $1,286 and the closing costs are $3,300.

If the homeowner plans on being in the home for the next 3 years and applies the aforementioned methodology then they would proceed with the refinance because they would calculate their “break-even” to be 10 months ($3,300 in closing costs divided by $325 per month in “savings”).  However, this would not be a good decision because the “savings” is not coming from reduced interest but the re-amortization of the mortgage.  In fact, during the first 10 months the homeowner would save only $459 in interest ($10,160 vs. $9,701).

This homeowner would actually be worse off after 3 years had they refinanced.  Over the first 3 years of the loan they would have saved only $1,049 of interest even though their cash-flow savings was $11,700.  You can see all the numbers HERE.

Grant it, I realize the numbers in this example are extreme.  A homeowner who was 10 years into a 30-year fixed rate mortgage with a rate of 5.00% probably intuitively knows that refinancing into a 4.75% rate at a cost of $3,300 doesn’t make sense.  However, I don’t think many financial professionals, personal finance writers, or even mortgage professionals understand the correct way to make these calculations.  Unless you’re an excel wizard it’s best to make sure your mortgage professional knows and understand these concepts so they can help guide you into the right decision.  When you inquire about refinancing be sure to ask them to make the correct calculations including total payments, projected interest, principal, and closing costs.

The article talks about how more and more refinance consumers are taking 20-year mortgages instead of the standard 30 year mortgages.

If you’ve never spoken with me about no closing cost (NCC) refinances you should.  Effectively, a NCC refinance allows you to replace your existing loan with a new one with a lower interest rate and not incur any costs.  In doing this we can discuss how to reduce your mortgage term or use the savings to eliminate other debts.  I’m always happy to provide a no obligation analysis for you to review.

In addition, they announced enhanced pricing on these programs which should improve mortgage rates.

The expansion is not likely to benefit many homeowners in the Portland-metro area because home prices have not fallen so significantly.  Other criteria still exist:

Among others here are the main criteria that we find inhibit our clients ability to utilize this program:

*When the existing mortgage was originated it could not have exceeded 80% of the homes value.  In other words, the homeowner must have had 20% down OR taken out a 2nd mortgage in place of having 20% equity.

*If the borrower has a 2nd mortgage then we need to obtain a subordination agreement with that lender stating they agree to resubordinate the existing 2nd mortgage behind a new first mortgage.  In this credit environment we don’t know of any 2nd lenders who are allowing this.

*The borrower’s existing mortgage must be a Fannie Mae or Freddie Mac mortgage.  Jumbo loan amounts are NOT covered nor are loans owned by “portfolio lenders” such as Washington Federal Bank or ING Direct among others.

If you have questions about this program and if it can benefit you please let us know.

Anyways, in the Wednesday edition James B. Stewart wrote a good piece on the process of refi’ing in today’s environment.  Here is a link to the article along with a couple excerpts-

Underwriting has gotten much more difficult-

Little did I know the ordeal I was about to embark upon. Getting to a successful closing became something of an obsession, and what seemed at times a second occupation. Several times I thought I’d reached the point where I couldn’t take yet another request for a document (often in the possession of third parties who never answer their phones). And I have a reasonably high credit rating, a low loan-to-value ratio, a low loan-to-income ratio, and a history of never having missed a mortgage payment. Can it be only a few years ago, anyone with a pulse got a mortgage?

Solutions?  Make the process SIMPLER.  Also, work with a professional who will educate you on your options in lawman terms-

So-called reforms that deprive people of choice and opportunity strike me as counterproductive. I’m all for reforms that clarify, simplify, and educate consumers to make better decisions, and I hope the Obama proposals will help achieve this.

Your existing mortgage lender will not only request that you pay-off the principal balance but also the per diem interest that has accrued from the date of your last mortgage payment.

For example, let’s assume you have a mortgage with a remaining principal balance of $250,000 and an interest rate of 7% ($48.61 per day) and you are planning on refinancing it.  The scheduled close date is set for November 15th.

When you go to close, your pay-off amount will be $250,729.17 ($250,000 + $48.61* 15 days)

Therefore, your pay-off amount is equal to:

Pay-off amount= Principal amount + per diem interest

As a side note, the new lender will collect per diem interest on the new mortgage from November 15th- November 30th which should be reflected on your good faith estimate provided by the new lender.

Keep in mind that when you refinance you effectively “skip” a payment.  The per diem interest that is collected through the closing essentially is the interest that otherwise would have been paid had you not skipped a payment.

But I will admit that this website does have some good information presented in an easy to read format.  I do take issue with a couple of the comments made on the site:

-The break-even worksheet on the site does not account for changes in amortization schedules between the existing and new mortgage in determining the break-even period.  This means the result will favor refinancing more often than not because an existing mortgage will typically have greater principal to be paid in the near-term compared to new mortgage. 

-The site also states, “Many financial advisers caution against cash-out refinancing to pay down unsecured debt (such as credit cards) or short-term secured debt (such as car loans).”  When done properly using idle equity in a person’s home to pay-off unsecured debt can free up significant cash-flow to use towards savings and investment goals.  I don’t know too many financial advisors who believe that is an adverse plan. 

Overall the site is pretty good but I still think its most important for an individual to clearly establish their objectives for refinancing before making an ultimate decision.  Here is a blog I posted about the subject a while back.

I encourage you to make comments about this posting below.