Buying out of Foreclosure

Foreclosure Auction Signs by Niall KennedyUS News & World Report quoted me in How to Buy a Foreclosed Home. It opens, 

AS HOME PRICES SOAR IN many cities, buyers may look to foreclosures to land bargains on houses. Foreclosure happens when a borrower can no longer make mortgage payments, and the lender seizes and then sells the home to recover losses.

Foreclosed homes are often sold for less than their market value.

That discount could bring a home within reach, but the financing and the home’s condition could present challenges. Before you bid on a foreclosed home, make sure you know the risks and the limitations.

Is It A Good Idea To Buy A Foreclosure Home?

Buying a foreclosure can save you some cash, but it comes with risks. If you pursue a foreclosure, it helps to have a “stomach of steel,” says David Reiss, law professor and research director of the Center for Urban Business Entrepreneurship at Brooklyn Law School.

Expect a lot more ups and downs than the typical homebuying process, says b, whose work focuses on real estate finance and community development.

Homebuying, including financing, can be more complicated with a foreclosed home. Yet the lure of savings can be irresistible.

“It can be like a 15% discount on your neighboring houses,” Reiss says. “So, it can be significant.”

But your savings will depend on the local real estate market and the condition of the foreclosed home, says Vince Malta, a San Francisco Realtor and president of the National Association of Realtors. Properties that need a lot of work sell for less than market value because of their condition and lower demand.

Not every foreclosure is a “steal” or a very good deal, Malta says.

“The truth is, the bank doesn’t want to ‘give’ the house away or sell it for less than it’s worth,” he says. “Foreclosures generally sell for very close to the appraised value.”

How Do You Buy a Foreclosed Home?

Buyers can find foreclosures at auctions, on home search sites such as Zillow and from traditional real estate agents, to name a few sources. You can finance or use cash to pay for a foreclosed home, but the former can be tricky.

Will you need cash to buy a foreclosure? You don’t necessarily need a full cash payment, but when you think you might buy at auction, you should prepare. Have some cash ready to make an immediate down payment.

Ask the auctioneer how much you might need in cash and how long you have to pay in full. Many foreclosures close within 30 to 45 days.

If you plan to finance the foreclosure, you will want to obtain a preapproval from a mortgage lender before the auction and bring it with you.

If you’re buying a bank-owned foreclosure at auction, you might want to apply for a loan from the same bank to simplify matters. Just be sure the bank offers a competitive interest rate.

If you’re buying a foreclosure from a bank, you could get a loan from the same bank to make your purchase. It’s not required but could make the process easier. Still, be sure the bank offers a competitive interest rate, as even a slightly higher rate could cost you thousands over the life of the loan.

Fair warning: Some banks will not want to finance foreclosures or will require large down payments because they can be risky investments.

Government-backed loan programs from the Department of Veterans Affairs or the Federal Housing Administration may offer financing options, but the property will need to meet standards for approval. Fannie Mae’s HomePath program helps homebuyers purchase properties the government-sponsored mortgage buyer has foreclosed on, Reiss says.

The program provides up to 3% in closing cost assistance for buyers who complete a homeowner education course.

“I have seen Fannie Mae put a lot of money into properties to get them in the condition for an owner-occupant to purchase them,” Malta says. “But I’ve also seen properties that would only accept cash offers due to the overwhelming deferred maintenance and damage to the property.”

An FHA 203(k) loan could be another smart choice for foreclosures in disrepair. The 203(k) program allows borrowers to finance repairs and renovations into the mortgage.

What Are the Risks of Buying a Foreclosure?

Buyers can embrace the process with eyes wide open, knowing the risks involved. The biggest risks can stem from buying property sight unseen.

“The big, scary thing is that with a number of foreclosures, you can’t actually inspect the property before you actually bid,” Reiss says. “That’s in part why the prices are below the market.”

Even if you pay for a home inspection, you typically have to buy the foreclosure “as is.” This means that if you purchase the home, any problem that pops up and the cost of fixing it are yours.

You can end up with a lot more of these problems in a foreclosed home, depending on the circumstances. A frustrated family might strip the home of valuable fixtures and appliances before leaving the house.

“Or they kind of just beat it up because they were angry about having to go through the foreclosure,” Reiss says.

A home lost to foreclosure could indicate a home neglected, Malta adds. “(You) have no idea what the previous owner has done for maintenance, or in many cases, hasn’t done,” he says.

How Can You Reduce the Risks of Buying a Foreclosure?

You can take a few steps to reduce the risks of buying a foreclosed property.

Get an inspection. “Buyers should absolutely hire their own inspector and thoroughly inspect the property,” Malta says.

In most instances, the bank will disclose any defects in the house, but sometimes the bank doesn’t have these details, he adds.

Research public property records. If you aren’t allowed to inspect the property, which may sometimes be the case, Reiss recommends researching its publicly available history. A property record search can reveal information about sales, tax liens, changes to square footage and additions to the property.

You can check the county tax office, which may have records available online.

“Maybe you’ll see some good news, like a boiler was replaced two years ago,” Reiss says. “Or maybe you’ll see some scary news, like there’s all these permits, and you don’t know if the work was completed.”

Do some informal due diligence. Start by visiting the house and performing a “curbside inspection” of your own, Reiss says.

“Even if you can’t go inside the house, you want to look at the property,” he says. “If you can peek in the windows, you probably want to peek in the windows.”

Knock on the doors of neighbors and see if they can answer your questions about the foreclosure. Tell them you want to bid on the home but need to learn all you can about the previous owners, including how long they lived in the house and how well they maintained it.

Ask if the home has had squatters or recent break-ins.

“Try to get all that information,” Reiss says. “Neighbors are probably going to have a good sense of a lot of that, and I think that kind of informal due diligence can be helpful.”

How To Buy A Foreclosed Home

photo by Taber Andrew Bain

US News & World Report quoted me in  How to Buy a Foreclosed Home. It opens,

As home prices soar in many cities, buyers might look to foreclosures as an affordable option for landing their dream home. Typically, a foreclosure occurs when a homeowner no longer can make the mortgage payments and the lender seizes the property. The lender then requires the former owner to vacate the property before offering it for sale, usually at a discounted price. In some cases, the home is auctioned off to the highest bidder.

Foreclosures offer home shoppers the potential to score a great deal, says Elizabeth Mendenhall, a Realtor in Columbia, Missouri, who is president of the National Association of Realtors.

“Sometimes people think a foreclosure only happens to the lower end of the market, but you can definitely find foreclosures at any price range,” she says.

But while buying a foreclosure can save you a lot of cash, it does come with risks. If you pursue a foreclosure, it helps to have a “stomach of steel,” says David Reiss, law professor and academic programs director of the Center for Urban Business Entrepreneurship at Brooklyn Law School.
“There’s going to be a lot more ups and downs” than in a typical homebuying process, says Reiss, whose work focuses on real estate finance and community development.

Why Buy a Foreclosure?

In recent years, foreclosure sales have been trending downward, according to national property data curating company Attom Data Solutions. That is largely because a strengthening U.S. economy has reduced the number of borrowers who lose their homes as a result of failing to pay the mortgage. In 2017, distressed home sales – including foreclosures and short sales – made up 14 percent of all U.S. single family home and condo sales, according to Attom Data Solutions. That number was down from 15.5 percent in 2016 and a recent high of 38.6 percent in 2011.

Still, some buyers look to foreclosures to get the best possible deal. Homes may be for sale in various states of foreclosure. For example, pre-foreclosure is a period when the owner has fallen behind on payments, but the lender has not actually taken the home from the owner. Homes sold at this point often go through the short sale process, where the lender agrees to accept an amount of money from the buyer that is less than what the current owner owes on the mortgage.

Properties that are already in foreclosure are sold at an online or offline auction, or by a real estate agent. The biggest lure of buying a foreclosure is the potential savings you get compared with buying a similar nondistressed property.

“It can be like a 15 percent discount on your neighboring houses,” Reiss says. “So, it can be significant.”

But Mendenhall says how much you will save depends on the local real estate market and the stage of foreclosure of the property.

The Risks of Buying a Foreclosure

Purchasing a foreclosure involves several substantial risks, so buyers must enter the process with their eyes wide open. In many cases, if you buy a foreclosure at auction, you must purchase the property sight unseen. Reiss says this is the biggest potential danger of buying a foreclosure.

“The big, scary thing is that with a number of foreclosures, you can’t actually inspect the property before you actually bid,” he says. “That’s in part why the prices are below the market.”

Even if you can get a professional inspection on a foreclosure, you typically have to buy the house “as is.” Once you purchase the home, any problems that pop up are yours – as is the responsibility for finding and paying for a remedy. Such problems are more likely in a foreclosure than in a nondistressed property. For example, in some cases, a frustrated family might strip the home of valuable elements before vacating the house.

“Or they kind of just beat it up because they were angry about having to go through the foreclosure,” Reiss says.

The mere fact that the home is vacant also can lead to problems. Reiss says a home is like a plant – if you don’t tend to it regularly, it can wither and die. “If you happen to leave it alone on its own for too long, water leaks in, pipes can burst, rodents can get in, just the elements can do damage,” he says.

Mendenhall adds that people who lose their homes to foreclosure typically have major financial troubles. That can trigger other troubles for the new owner. “If the previous owner was in financial distress, there’s a chance that there’s more maintenance and work maybe that they haven’t completed,” she says.

Reducing the Dangers of Buying a Foreclosure

There are a few things you can do to mitigate the risks associated with buying a foreclosure. For starters, see if you can get a professional inspection of the property. Although buyers often cannot inspect a foreclosure property, that is not always the case. So, be sure to ask a real estate agent or the seller about hiring a home inspector.

“Even though it may extend the process, if you can have a qualified inspector come in, you can know a little bit more about what you’re getting into,” Mendenhall says.

If you can’t inspect the property, Reiss recommends researching its history. Look at publicly available records to find out when the property was last sold and how long the current owner had possession. Also, check whether building permits were drawn and what type of work was done. “Maybe you’ll see some good news, like a boiler was replaced two years ago,” Reiss says. “Or maybe you’ll see some scary news, like there’s all these permits and you don’t know if the work was completed.”

Also, visit the house and perform a “curbside inspection” of your own, Reiss says. “Even if you can’t go inside the house, you want to look at the property,” he says. “If you can peek in the windows, you probably want to peek in the windows.”

Knock on the doors of nearby neighbors. Tell them you want to bid on the property but need to learn all that you can about the previous owners, including how long they lived in the home and whether they took care of it. And ask if there have been any signs of squatters or recent break-ins.

“Try to get all that information,” Reiss says. “Neighbors are probably going to have a good sense of a lot of that, and I think that kind of informal due diligence can be helpful.”

Working with a real estate agent experienced in selling distressed property may help you avoid some of the potential pitfalls of buying foreclosures, Mendenhall says. Some agents have earned the National Association of Realtors’ Short Sales and Foreclosure Resource Certification, or SFR. Such Realtors can help guide you through processes unique to purchasing distressed properties, Mendenhall says.

How to Find a Foreclosure

You can find foreclosures by searching the listings at bank websites, including those of giants such as Wells Fargo and Bank of America. The government-sponsored companies Fannie Mae and Freddie Mac also have listings on their websites.

The federal government’s Department of Housing and Urban Development owns and sells foreclosed homes. You can find listings on the website.

Private companies such as RealtyTrac offer foreclosure listings online, typically for a fee. Finally, you can contact a real estate agent who will find foreclosures for you. These agents may help you find foreclosures before others snatch them up.

Is a Foreclosure Right for You?

Before you pursue a foreclosure, Reiss encourages you to ask yourself whether you are in a good position to take on the risk – and, hopefully, to reap the reward – of buying a foreclosure. It is possible to use conventional financing, or even a loan from the Federal Housing Administration or Department of Veterans Affairs, to buy a foreclosure. However, people with deeper pockets are often better candidates for buying a foreclosure.

Because the process can be highly competitive, buyers with access to large amounts of cash can swoop in and land the best deals. “You can get financing, but you need to get it quickly,” Reiss says. “I think a lot of people who go into purchasing foreclosure(s) want to have the cash to just kind of act.”

Sellers of distressed properties love cash-only buyers, because the home can be sold without a lender requiring either a home appraisal or a home inspection. “So, the more cash you have on hand, the more likely you’re playing in those sandboxes,” Reiss says.

In addition, buyers of foreclosures often need to spend money to bring a property up to code or to make it competitive with other homes in the neighborhood. “Have a big cushion in case the building is in much worse condition than you expected,” Reiss says.

He cites the example of someone who buys a foreclosure, only to discover that the piping has been stripped out of the basement and will cost $10,000 to repair and replace. “You need to know that you can handle that one way or the other,” Reiss says.

People with solid home maintenance and repair skills also are good candidates for buying a foreclosure. “I think if you’re a handy person, you might be able to address a lot of the issues yourself,” Reiss says. He describes such buyers as anyone who has “a can-do attitude and is looking to trade sweat equity for home equity.”

Reiss and Mendenhall agree that flexibility is crucial to successfully shopping for and purchasing a foreclosure. Mendenhall notes that a foreclosure sale can take a long time to complete. “It can be a long process, or a frustrating one,” she says. “It can depend upon where they are in the foreclosure process. It can take a much longer time to go from contract to close.”

For that reason, a foreclosure might not make sense for buyers who need to move into a property quickly, she says. Also, think hard about how you really feel about buying a house that needs extensive renovation work that might take a long time to complete.

“It can be hard for some people to live in a property and do repairs at the same time,” Mendenhall says.

Rising Rates and The Mortgage Market

The Urban Institute’s Housing Finance at a Glance Chartbook for March focuses on how rising interest rates have been impacting the mortgage market. The chartbook makes a series of excellent points about current trends, although homeowners and homebuyers should keep in mind that rates remain near historic lows:

As mortgage rates have increased, there has been no shortage of articles explaining the effect of rising rates on the mortgage market. Mortgage rates began their present sustained increase immediately after the last presidential election in November 2016, 20 months ago. Enough data points have become available during thisperiod that we can now measure the effects of rising rates. Below we outline a few.

Refinances: The most immediate impact of rising rates is on refinance volumes, which fall as rates rise. For mortgages backed by Fannie Mae and Freddie Mac, the refinance share of total originations declined from 63 percent in Nov 2016 to 46 percent today (page 11). For FHA, VA and USDA-insured mortgages, the refinance share dropped from 44 percent to 35 percent. In terms of volume, Fannie Mae and Freddie Mac backed refinance volume totaled $390 billion in 2017, down from $550 billion in 2016. For Ginnie Mae, refi volume dropped from $197 billion in 2016 to $136 billion in 2017. Looking ahead, most estimates for 2018 point to a continued reduction in the refi share and origination volumes (page 15).

Originator profitability: Of course, less demand for mortgages isn’t good for originator profitability because lenders need to compete harder to attract borrowers. They do this often by reducing profit margins as rates rise (conversely, when rates are falling and everyone is rushing to refinance, lenders tend to respond by increasing their profit margins). Indeed, since Nov 2016, originator profitability has declined from $2.6 per $100 of loans originated to $1.93 today (page 16). Post crisis originator profitability reached as high as $5 per $100 loan in late 2012, when rates were at their lowest point.

Cash-out share: Another consequence of falling refinance volumes is the rising share of cash-out refinances. The share of cash-out refinances varies partly because borrowers’ motivations change with interest rates. When rates are low, the primary goal of refinancing is to reduce the monthly payment. Cash-out share tends to be low during such periods. But when rates are high, borrowers have no incentive to refinance for rate reasons. Those who still refinance tend to be driven more by their desire to cash-out (although this doesn’t mean that the volume is also high). As such, cash-out share of refinances increased to 63 percent in Q4 2017 according to Freddie Mac Quarterly Refinance Statistics. The last time cash-out share was this high was in 2008.

Industry consolidation: A longer-term impact of rising rates is industry consolidation: not every lender can afford to cut profitability. Larger, diversified originators are more able to accept lower margins because they can make up for it through other lines of business or simply accept lower profitability for some time. Smaller lenders may not have such flexibility and may find it necessary to merge with another entity. Industry consolidation due to higher rates is not easy to quantify as firms can merge or get acquired for various reasons. At the same time, one can’t ignore New Residential Investment’s recent acquisition of Shellpoint Partners and Ocwen’s purchase of PHH. (5)

Nonbanks and The Next Crisis

 

 

Researchers at the Fed and UC Berkeley have posted Liquidity Crises in the Mortgage Markets. The authors conclusions are particularly troubling:

The nonbank mortgage sector has boomed in recent years. The combination of low interest rates, well-functioning GSE and Ginnie Mae securitization markets, and streamlined FHA and VA programs have created ample opportunities for nonbanks to generate revenue by refinancing mortgages. Commercial banks have been happy to supply warehouse lines of credit to nonbanks at favorable rates. Delinquency rates have been low, and so nonbanks have not needed to finance servicing advances.

In this paper, we ask “What happens next?” What happens if interest rates rise and nonbank revenue drops? What happens if commercial banks or other financial institutions lose their taste for extending credit to nonbanks? What happens if delinquency rates rise and servicers have to advance payments to investors—advances that, in the case of Ginnie Mae pools, the servicer cannot finance, and on which they might take a sizable capital loss?

We cannot provide reassuring answers to any of these questions. The typical nonbank has few resources with which to weather these shocks. Nonbanks with servicing portfolios concentrated in Ginnie Mae pools are exposed to a higher risk of borrower default and higher potential losses in the event of such a default, and yet, as far as we can tell from our limited data, have even less liquidity on hand than other nonbanks. Failure of these nonbanks in particular would have a disproportionate effect on lower-income and minority borrowers.

In the event of the failure of a nonbank, the government (through Ginnie Mae and the GSEs) will probably bear the majority of the increased credit and operational losses that will follow. In the aftermath of the financial crisis, the government shared some mortgage credit losses with the banking system through putbacks and False Claims Act prosecutions. Now, however, the banks have largely retreated from lending to borrowers with lower credit scores and instead lend to nonbanks through warehouse lines of credit, which provide banks with numerous protections in the event of nonbank failure.

Although the monitoring of nonbanks on the part of the GSEs, Ginnie Mae, and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data, and staff resources still seem somewhat lacking relative to the risks. Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual nonbanks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business. We write this paper with the hope of elevating this question in the national mortgage debate. (52-53)

As with last week’s paper on Mortgage Insurers and The Next Housing Crisis, this paper is a wake-up call to mortgage-market policymakers to pay attention to where the seeds of the next mortgage crisis may be hibernating, awaiting just the right conditions to sprout up.

Can I Refinance?

photo by GotCredit.com

LendingTree quoted me in Can I Refinance? Refinance Requirements for Your Mortgage. It opens,

While there are many reasons to refinance a mortgage, one of the biggest factors at play is whether or not you’ll be able to get a better interest rate. When interest rates drop, homeowners are incentivized to refinance into a new mortgage with a lower rate and better terms because it can potentially save them a boatload of money over the course of their loan.

Not only can refinancing save money on interest payments, but it can lead to lower monthly payments, or be a way to get rid of a pesky primary mortgage insurance requirement once you’ve earned enough equity in your home. Homeowners can also tinker with their repayment timeline when they refinance, choosing to lengthen their loan term or even shorten it to pay off their home faster.

The first question before you refinance your mortgage is simple: Does it make financial sense? Refinancing a mortgage comes with the same closing costs and fees as a regular mortgage, so you must stand to earn more by refinancing than you’ll pay to do it.

If you’ve had the same mortgage rate since the aughts or earlier, chances are you could have much to gain by refinancing in today’s lower rate environment.

The average interest rate on a 30-year, fixed-rate mortgage hit a low point of 3.31% on Nov. 21, 2012 and hasn’t budged all too much since then. Rates currently stand at 4.32% as of Feb. 8, 2018. By comparison, rates were routinely in the double digits in the 80s and early 90s.

Will rates continue on the upward trend? Unfortunately, nobody knows. But rate behavior will very likely play a key role in your decision.

Once you’ve decided refinancing makes financial sense, the next question should be this: What does it take to qualify? That’s what we’ll cover in this guide.

If you hope to refinance before rates climb any further, it’s smart to get your ducks in a row and find out the refinance requirements for your mortgage right away. Keep reading to learn the minimum requirements to refinance your mortgage, how your credit score may come into play and what steps to take next.

Can you refinance your home?

Lenders consider three main criteria when approving consumers for a home refinance – income, equity, and credit.

  • Debt and income.
  • Equity. Equity is important because lenders want to confirm possibly getting their money back out of your home if you default on your mortgage.
  • Credit. Any lending situation will involve a credit check. “They look at your credit score to see if you have the willingness to pay your mortgage back – to see if you’re creditworthy,” said David Reiss, Professor of Real Estate Law at The Center for Urban Business Entrepreneurship at Brooklyn Law School. “Do you have a low credit score or a high credit score? Do you pay your bills on time?” he asked. “These are all things your lender needs to know.”

While the above factors play a role in whether you’ll qualify to refinance your home, lenders do get fairly specific when it comes to how they gauge your income to determine affordability. Since the amount of income you need to qualify for a new mortgage depends on the amount you wish to borrow, lenders typically use something called “debt-to-income ratio” to measure your ability to repay, says Reiss.

Your debt-to-income ratio (DTI)

During the underwriting process for a conventional loan, lenders will look at all the factors that make them comfortable extending you a loan. This includes your income and your debt levels, says Reiss. “Debt-to-income ratio is an easy way for lenders to determine if you have too many debt payments that might interfere with your home mortgage payment in the future.”

To come up with a debt-to-income ratio, lenders look at your debts and compare them with your income.

But, how is your debt-to-income ratio determined? Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.

In the real world, someone’s debt-to-income ratio would work something like this:

Imagine one of your neighbors has a gross monthly income of $4,000, but they pay out $3,000 per month toward rent payments, car loans, child support, and student loans. Their debt income ratio would be 75% because $3,000 divided by $4,000 is .75.

Reiss says this factor is important because lenders shy away from consumers with debt-to-income ratios that are considered “too high.” Generally speaking, lenders prefer to loan money to borrowers with a debt-to-income ratio of less than 43% but 36% is ideal.

In the example above where your neighbor has a monthly gross income of $4,000, this means he or she may have to get all debt payments down to approximately $1,700 to qualify for a mortgage. ($1,700 divided by $4,000 = .425 or 42.5%).

There are exceptions to the 43% DTI rule, according to the Consumer Financial Protection Bureau. Some lenders may offer you a mortgage if your debt-to-income ratio is higher than 43%. Situations, where such mortgages are offered, include when a borrower has a high credit score, a stellar record of repayment or both. Still, the 43% rule is a good rule of thumb to follow when it comes to traditional mortgages.

Other financial thresholds

If you plan to refinance your home with an FHA mortgage, your housing costs typically need to be less than 29% of your income while your total debts should be no more than 41%.

However, the U.S. Department of Housing and Urban Development, which oversees FHA loans, also notes that potential borrowers with lower credit scores and higher debt-to-income ratios may need to have their loans manually underwritten to ensure “adequate consideration of the borrower’s ability to repay while preserving access to credit for otherwise underserved borrowers.”

Mortgage broker Mark Lewin of Caliber Home Loans in Indiana even says that in his experience, individuals with good credit and “other compensating factors” have secured FHA loans with a total debt-to-income ratio of 55%.

Of course, those who already have an FHA loan may also be able to refinance to a lower rate with no credit check or income verification through a process called FHA Streamline Refinancing. Your debt-to-income ratio won’t even be considered.

A VA loan is another type of home loan that has its own set of debt-to-income requirements. Generally speaking, veterans who meet eligibility requirements for the program need to have a debt-to-income ratio at or below 41% to qualify. However, you may be able to refinance your home with an Interest Rate Reduction Refinance Loan from the VA if you already have a VA loan. These loans don’t have any underwriting or appraisal requirements.

Equity requirements

Equity requirements to refinance your mortgage are typically at the sole discretion of your lender. Where some home mortgage companies may require 20% equity to refinance, others have much lighter requirements.

To find out what your home is worth and how much equity you have, you typically need to pay for a home appraisal, says Reiss. “Appraisals are typically required because you have to be able to prove the value of your home in order to refinance, just like you would with a traditional mortgage.”

There are a few exceptions, however. Mortgage refinancing options that may not require an appraisal include:

  • Interest Rate Reduction Refinance Loans from the VA
  • FHA Streamline Refinance
  • HARP (Home Affordable Refinance Program) Mortgages

Explaining loan-to-value ratio, or LTV

Loan-to-value ratio is a figure determined by assessing how much you owe on your home in relation to its value. If you owe $80,000 on a home worth $100,000, for example, your LTV would be 80% and you would have 20% equity in your home.

This ratio is important because it can determine whether your lender will approve you for a refinance. It can also determine the interest rates you’ll pay and other terms of your loan. If you have less than 20% equity in your home, for example, you may face higher interest rates and fees when you go to refinance.

Having less than 20% equity when you refinance may also cause you to have to pay PMI or private mortgage insurance. This mortgage insurance usually costs between 0.15 to 1.95% of your loan amount each year. If you have less than 20% equity in your home already, you’re already likely to be paying for this coverage all along. However, it’s still worth noting that, if you refinance with less than 20% equity, this coverage will once again get tacked onto your mortgage amount.

Is 80% LTV mandatory?

Your LTV and equity aren’t the end-all, be-all when it comes to your loan refi application. In fact, Reiss says that lenders he has experience with don’t absolutely require borrowers to have 20% equity or a loan-to-value ratio of 80% — so long as they score high on other measures.

“If you meet the lender’s requirements in terms of income and credit, your loan-to-value ratio doesn’t matter as much — especially if you have excellent credit and a solid payment history,” he said. However, lenders do prefer lending to consumers who have at least 20% equity in their homes.

Reiss says he always refers to 20% equity as the “gold standard” because it’s a goal everyone should shoot for. Not only does having 20% equity in your home when you refinance help you avoid paying for the added expense of PMI, but it can help provide more stability in your life, says Reiss: “Divorce, disease, and death in the family can and do happen, but having equity in your home makes it easier to overcome anything life throws your way.”

For example, having more equity in your home makes it easier to refinance into the best rates possible. Having a lot of equity is also ideal when you have to sell your home suddenly because it means you’re more likely to turn a profit and less likely to take a loss. Last but not least, if you have plenty of equity in your home, you can access that cash for emergency expenses via a home equity loan or HELOC.

“Home equity is a big source of wealth for American families,” he said. “The more equity you have, the more resources you have.”

Fortunately, many households are enjoying greater home equity today, as home values have continued to increase since the housing crisis.

Your credit score

The third factor that can impact your ability to refinance your home is your credit score. When a lender decides whether to give you a mortgage or not, they typically offer the best rates to people with very good credit, or with FICO scores of 740 or higher, according to Reiss.

“The lower your credit score, the higher your interest rate may be,” he said. “If your credit score is bad enough, you may not be able to refinance or get a new mortgage at all.”

The FICO scoring model’s main website, myFICO.com, seems to echo Reiss’ comments. As it notes, a “very good” score is any FICO score in the 740-799 range. If you earn a 740+ FICO, you’re above the national average and have a greater likelihood of getting credit approval and being offered lower interest rates.

Don’t stress about getting a perfect 850 FICO score either. In reality, rates stop improving much once you pass 740.

Treasury’s Take on Housing Finance Reform

Treasury Secretary Mnuchin Being Sworn In

The Department of the Treasury released its Strategic Plan for 2018-2022. One of its 17 Strategic Objectives is to promote housing finance reform:

Support housing finance reform to resolve Government-Sponsored Enterprise (GSE) conservatorships and prevent taxpayer bailouts of public and private mortgage finance entities, while promoting consumer choice within the mortgage market.

Desired Outcomes

Increased share of mortgage credit supported by private capital; Resolution of GSE conservatorships; Appropriate level of sustainable homeownership.

Why Does This Matter?

Fannie Mae and Freddie Mac have been in federal conservatorship for nine years. Taxpayers continue to stand behind their obligations through capital support agreements while there is no clear path for the resolution of their conservatorship. The GSEs, combined with federal housing programs such as those at the Federal Housing Administration and the Department of Veterans Affairs, support more than 70 percent of new mortgage originations. Changes should encourage the entry of greater private capital in the U.S. housing finance system. Resolution of the GSE conservatorships and right-sizing of federal housing programs is necessary to support a more sustainable U.S. housing finance system. (16)

The Plan states that Treasury’s strategies to achieve these objectives are to engage “stakeholders to develop housing finance reform recommendations.” (17) These stakeholders include Congress, the FHFA, Fed, SEC, CFPB, FDIC, HUD (including the FHA), VA, Fannie Mae, Freddie Mac, the Association of State Banking Regulators as well as “The Public.” Treasury further intends to disseminate “principles and recommendations for housing finance reform” and plan “for the resolution of current GSE conservatorships.” (Id.)

This is all to the good of course, but it is at such a high level of generality that it tells us next to nothing. In this regard, Trump’s Treasury is not all that different from Obama and George W. Bush’s. Treasury has not taken a lead on housing finance reform since the financial crisis began. While there is nothing wrong with letting Congress take the lead on this issue, it would move things forward if Treasury created an environment in which housing finance reform was clearly identified as a priority in Washington. Nothing good will come from letting Fannie and Freddie limp along in conservatorship for a decade or more.

Loan Mods Amidst Rising Interest Rates

photo by Chris Butterworth

The Urban Institute’s Laurie Goodman et al. have posted Government Loan Modifications: What Happens When Interest Rates Rise?. This brief is another product of the newly formed Mortgage Servicing Collaborative. This brief

examines the current loan modification product suite for government loans insured or guaranteed by the Federal Housing Administration (FHA), US Department of Veterans Affairs (VA), or the US Department of Agriculture (USDA). When a delinquent borrower with a government loan obtains a modification, the mortgage rate is typically reset to the prevailing market rate, which can be higher or lower than the original note rate. When the market rate is below the original rate, providing payment reduction becomes inherently easier and less expensive for the investor. Conversely, when market rates are above the note rate, providing payment reduction becomes more expensive and challenging, making it more difficult to cure the delinquency. This can result in more redefaults and foreclosures, larger losses for government insurers, and greater distress for borrowers, communities, and neighborhoods. In addition, most government mortgage borrowers are first-time homebuyers and minorities, who tend to have limited incomes and savings, making loan modifications all the more important. (1)

Given the recent upward trend in interest rates, this is more than a theoretical exercise. And indeed, the brief “explains why FHA, VA, and USDA borrowers who fall behind on their payments are unlikely to receive adequate payment relief when the market interest rate is higher than the original note rate. ” (3)

The brief outlines some options that could increase payment relief for those borrowers, including deploying a 40-year extended term and principal forbearance to reduce the monthly mortgage payment. The brief acknowledges that there are barriers to implementing the options it has identified but it also proposes ways to overcome those barriers.

As I had stated previously, the Mortgage Servicing Collaborative is providing sorely needed guidance through some of the darker corners of the mortgage market. This brief sheds some welcome light on an obscured problem that may cause trouble in the years to come.