Interest rates have been at historically low levels for some time now. Some borrowers have refinanced two or three times, but there are others who so far have allowed the opportunity to pass them by. I am not referring to borrowers who haven’t refinanced because they can’t meet today’s standards. My focus is on those who can refinance profitably but don’t for a variety of reasons.
ERRONEOUS BELIEFS: The following beliefs that prevent or discourage
refinancing have been related to me by borrowers. All are false:
—Borrowers have to wait some minimum period after taking a mortgage before they can refinance.
—The borrower who refinances loses the benefit of principal payments already made.
—The borrower who paid points to reduce the interest rate on the
current mortgage should wait until the interest savings have covered the
cost of the points.
—The borrower who has had a mortgage for a long time has to begin the process of paying off their debt all over again.
—It is better for a borrower who has been making extra payments to continue that practice, rather than refinance.
UNREALISTIC FEAR OF ADJUSTABLE-RATE MORTGAGES: There are borrowers
with fixed-rate mortgages, or FRMs, who would not profit from
refinancing into another FRM, but who would profit from refinancing into
a lower-rate adjustable-rate mortgage — but they don’t because of fear
of a possible rate increase. In many cases, this fear is not justified
because the borrower can pay off the loan within the initial fixed rate
period on the adjustable-rate mortgage, or ARM, which can be five, seven
or 10 years.
To pay off the loan fully within the initial ARM rate period, the
borrower must have the capacity to make payments larger than the
required payment on the ARM. The previous payment on the FRM might be
large enough to do the trick, or it might not. Even if the borrower
can’t pay off completely within the initial rate period, paying a higher
rate for a few years on a much reduced balance will not come close to
wiping out the interest savings during the preceding years.
FAILURE TO EXPLOIT AN INVESTMENT OPPORTUNITY: Many mortgage borrowers
can’t refinance profitably, or think they can’t, because their house
has declined in value and a refinance would require the purchase of
mortgage insurance. But if they have investment assets that can be
liquidated to pay down their mortgage balance, the rate of return on
investment will be far higher than the return they are earning on those
assets now. This is called “cash-in refinancing” because the borrower is
putting cash into the transaction.
Here is an example: John has a 6 percent mortgage with 300 months to
go and a $100,000 balance, but his house is worth only $100,000, which
makes him ineligible for a refinance. But if he pays down the balance to
$80,000, he can refinance into a 4.5 percent loan with closing costs of
2 percent. If he stays in the house for 5 years, the rate of return on
his investment, consisting of $20,000 in balance pay-down plus $1,600 in
closing costs, would be more than 9 percent. The return is riskless to
REJECTED AND GAVE UP: Some borrowers have not refinanced because they
tried and were rejected, and then gave up. But not all rejections are
created equal — depending on the reason, some deficiencies are fixable.
Here are a few:
—You met the underwriting standards of the federal agencies — Fannie
Mae, Freddie Mac, the Federal Housing Administration — but not those of
the particular lender who rejected you. Some lenders have “overlays”
that impose more restrictive requirements than those of the agencies,
and where this is the case, you might well be approved by going to
—You were rejected because your credit score was too low for reasons
that are quickly remediable. Examples would be scores lowered by a
reporting mistake, or by credit card balances that are large relative to
—You were rejected because your equity in the property was too small
based on a faulty appraisal. A new appraisal obtained through a
different lender could provide a different outcome.
—You were rejected because your debt-to-income ratio was too high and
you have the means to reduce it — for example, by borrowing against a
401(k) in order to pay down other debt.
Jack Guttentag is professor emeritus of finance at the Wharton
School of the University of Pennsylvania. More information can be found