Escaping From An Adjustable Rate Mortgage Is Not Easy
The Bergen Record has an interesting article about the difficulties property owners are facing trying to refinance adjustable rate mortgages into fixed rate loans. Many people are now in foreclosure because they took interest only mortgages that kept their beginning mortgage payments artificially low. Many of these “ARMs” are now resetting and the mortgage payments are increasing to levels that are not affordable.
Refinancing replaces ARM loans
Sunday, July 22, 2007
By KATHLEEN LYNN, STAFF WRITERFaced with rising monthly payments, many homeowners who took out adjustable-rate mortgages a couple of years ago now want to refinance into fixed-rate loans.
“People are moving toward safe and secure fixed-rate mortgages,” said Susan M. Wachter, a real estate professor at the Wharton School of Business at the University of Pennsylvania. “There’s an increasing recognition out there of the potential for mortgage payment shocks with adjustable-rate mortgages.”
But some who want to refinance now may find that tighter lending standards, combined with flat or lower house values, have closed off that option.
A buyer who took out a no-down-payment loan, for example, may not have any equity because house values have flattened or even declined in the last couple of years. And lenders are no longer making loans where the homeowner has no skin in the game.
“A lot of those products have gone away,” said Robert Wilderotter of the Real Estate Mortgage Network in River Edge.
He predicted that some of these homeowners — in a house they can’t afford, with no way to get a cheaper mortgage or sell their house at a profit — will end up in foreclosure.
Many recent homeowners bought their houses using mortgages that kept payments artificially low in the first three to five years. The loans had adjustable interest rates or allowed homeowners to start with “interest-only” payments. And with some “option” loans, homeowners could even pay less than the full monthly interest, adding that amount to the loan balance.
But you’ve got to pay sometime, and for lots of people, “sometime” is approaching fast.
“Borrowers have a new understanding of some of the pitfalls of these exotic instruments,” Wachter said.
Homeowners who are able to refinance into fixed rates are now locking in rates around 6.8 percent. While that’s higher than the levels of a couple of years ago, it’s still lower than what people could face when their adjustable mortgages ratchet up – 7 percent, 8 percent or higher, depending on their creditworthiness and the details of their loans.
According to the Joint Center for Housing Research at Harvard, 14 percent of refinances in the fourth quarter of 2006 involved switching from an adjustable to a fixed loan.
William Gillette is one home buyer who has refinanced into a fixed-rate loan. He was helped by Citizen Action, the public advocacy group.
When Gillette bought his two-family house in Newark a few years ago, he relied on his real estate agent to find the mortgage, rather than do the research himself.
“That was a mistake in itself,” said Gillette, a bus driver. “Nobody was working for my best interest. They told me they could put me in a house for $1,400 a month for the mortgage.”
The lender told him not to fret that the rate was adjustable – meaning that it would float up or down with prevailing market rates. But Gillette came to realize that after the interest rate went up, he’d have trouble paying.
So he went to Citizen Action, which helped him arrange a fixed-rate loan with the Bank of America.
“I’m happy with it. They saved the house for me,” he said. His new monthly payment is $2,253; that’s manageable with the rent paid by his tenant.
Steve Graber, president of Pan Am Mortgage in Saddle Brook, said a few years ago, when interest rates were at 40-year lows, many borrowers were able to get adjustable-rate loans starting out at 4 percent. Now that the Federal Reserve has increased rates and their mortgages have re-set, “they’re paying 8 or even 9 percent,” he said. So-called subprime loans – made to borrowers with tarnished credit records – are resetting at the highest rates.
With rates rising, Victor Polce, president of Customized Mortgage Solutions in Old Tappan, said his company has been calling clients to see if they want to refinance to a fixed-rate loan.
“You’ve got too much on your plate to worry about where interest rates are going every day,” said Polce, who is also mayor of Old Tappan.
Counting the costs of title insurance, appraisals, application fees and other costs, refinancing a mortgage costs about 0.75 percent to 1.25 percent of mortgage amount, Polce said.
“But you’ve got to balance that off against how much you’re going to be saving on a monthly basis,” he said.
Douglas Duncan, chief economist of the Mortgage Bankers Association, said there’s an increased demand for fixed-rate, interest-only loans – in which the borrower starts out paying only the interest, not the principal. Interest-only loans became popular as home prices rose in the first half of this decade, because they keep payments low in the early years of the loan.
In some cases, borrowers take on these loans because they can’t afford to buy otherwise. That’s a worrisome trend, because when they have to start paying on principal, they may not be able to carry the monthly payments.
But in some cases, Duncan said, borrowers simply “have an alternate use for the money that would go into principal payments” – for example, investing in their 401(k) retirement plans.
And a fixed-rate interest-only loan is not as risky as adjustable interest-only loans. Because the interest rate is fixed, “it’s much easier for them to predict what their payments will be” in the future, Duncan said. With an adjustable rate, there’s uncertainty about how high the rate will go.
Alex Grinewicz, chief lending officer for Columbia Bank in Fair Lawn, expects the refinance rush to pick up even more next year. “That’s when a lot of adjustables are coming due,” he said.
He said homeowners should consider refinancing now because interest rates are still at relatively low rates, and banks are aggressively courting business.
But lenders are undeniably more conservative than they were a few years ago. The mortgage industry has tightened loose lending standards, under pressure from regulators. They’re also reacting to the fact that many subprime borrowers are having trouble making their monthly payments.
Some who were subprime borrowers a few years ago may be able to move into the regular mortgage market, if they have improved their credit scores in the meantime, said Keith Gumbinger, vice president of HSH Associates, a Pompton Plains company that tracks the market. Those borrowers can now refinance to a loan with an interest rate below 7 percent, he said.
But others will not be so lucky. And it’s not as if they can solve their problems by simply selling. The housing market has softened, and sellers who bought in the last couple of years may get less than they paid. Buyers are hanging back, hoping to get a better deal if house prices fall further, said Alex Giassa, a mortgage consultant with First Interstate Financial in Paramus.
“The buyers are very tentative,” Giassa said.
Homeowners in such a bind are advised to call their lenders as soon as they realize they’re going to have problems paying. They may be able to work out payment plans that give them a break.
“You don’t want to wait till you haven’t made payments for several months,” Gumbinger said. “That makes it that much more adversarial.”
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Escape routeLooking to get out of an adjustable loan? Here’s what you need to do:
• Check to see if there are pre-payment penalties in your loan. Lenders chartered in New Jersey are not permitted to charge pre-payment penalties, but federally chartered institutions can, according to the state Department of Banking and Insurance. Even if there are penalties, it could still be worthwhile to refinance, but you have to factor in the cost of the penalties.
• Calculate how much it would cost to refinance the loan (typically it’s about 1 percent of the loan amount). Figure out how long it will take you to recoup that cost through lower monthly payments.
• Check your credit reports for free at annualcreditreport.com or by calling 877-322-8228. If there are any inaccuracies on the reports, clear them up.
• Check your credit score at myfico.com (cost: $15.95). If your score is below 620, consider trying to improve the score before you apply for a mortgage, advised Susan M. Wachter of the University of Pennsylvania. A higher score can get you a dramatically lower interest rate. To improve your score, pay off your credit cards.
• Shop around for the best deal on a fixed-rate loan.