Refinance

Refinance borrowers frequently ask themselves "Why all the fuss? I already have a loan. I just want to lower my rate!" Many borrowers do not fully understand the anatomy of a mortgage refinance. A common misconception is that the lender just unilaterally reduces the interest rate and changes the required monthly payment to agree with the new, lower rate. So, why then all the fuss? Well, what was just described is not a refinance but, rather, a "modification and extension" agreement and their occurrence is extremely rare. In today’s world a mortgage loan is typically "originated" by one lender and then, shortly after closing, another lender takes over the "servicing" of the loan, that is, collects the monthly payments from and maintains correspondence with the borrower, handles the escrow and disbursement of property taxes and insurance, and forwards the monthly interest income to the owners of the mortgage note. Ownership of mortgage loans in America these days is typically accomplished by purchasing "mortgage backed securities". Retail lenders originate the loans and sell them to wholesale lenders who then "package" the loans into homogenous "pools". The fact that all the loans in any one "pool" of home mortgages have the same length of time for repayment, rate of interest and other terms (making them homogenous in nature) facilitates the securitization of the loans and thereby helps to maintain a large, active market of funds available to finance and "re-finance" homes all across America. The securitizing lenders sell bonds in the financial markets, which are "backed" by the pools of loans, hence the term "mortgage backed securities". FANNIE MAE (the Federal National Mortgage Association), GINNY MAE (the Government National Mortgage Association) and FREDDIE MAC (the Federal Home Loan Mortgage Corporation) are securitizing lenders whose names many have heard of. The sale of financial securities in America is very strictly regulated and these securitizing lenders must issue "warrants and representations" stating the characteristics of all the loans backing the bonds. Loans in homogenous pools cannot be "modified" because they would no longer be able to be included in the pool. Therefore, to refinance or change the terms of the mortgage on any one home, a new loan must be "originated" with the proceeds being used to pay off the original loan.

Refinance borrowers also frequently ask "Why do the numbers keep changing?" This new loan that is being originated must typically meet the same underwriting guidelines that purchase loans are required to meet. Refinances run the gamut from "streamlined" transactions (usually involving FHA insured or VA guaranteed loans) requiring minimal effort and documentation on the borrowers’ part all the way to transactions that are just as documentation intensive as purchase loans. A refinance transaction differs from a purchase transaction in several ways. The numbers in a purchase loan typically do not change much from application to closing. Both the purchase price and the amount of the down payment are known up front and typically do not change. Though the "closing costs" and "pre-paids" can vary from company to company they are somewhat standardized throughout the industry and certainly tend to be standard from loan to loan at any one mortgage company. If the numbers in a purchase transaction tend to be "static" the numbers in a refinance transaction tend to change from application to closing. Several factors account for these changing numbers or how the deal is "put together". At the time of application the borrowers’ estimate of their loan balance is used as the baseline or beginning point in putting the new loan together. Eventually, a "payoff statement" is obtained from the present servicing lender indicating the exact amount required to payoff the present loan including both principal and accrued interest through the estimated date of receipt of the payoff, as well as any fees or other charges assessed by the servicing lender. Also, there could be a shortage in the escrow account due to under collection of the property taxes and insurance. If so, this shortage would have to be paid before the present lender will release their lien on the property. But this "exact" payoff figure is subject to change over time as the homeowner continues making monthly payments and, at the same time, interest continues to accrue against the balance on a daily basis. Furthermore, a new escrow account must be set up and a new insurance policy may have to be purchased, depending on the amount of time remaining on the present policy. Typically, we try to make the numbers work where the borrower does not have to come out of pocket with much money at closing but, in Texas, we have to be careful not to give any cash back to the borrower lest we trigger provisions of the home equity law.

Here’s a pleasant surprise! Homeowners usually expect to get a lower interest rate and a lower monthly payment as a result of a mortgage refinance but many of them are pleasantly surprised to find out that a refinance can frequently be done with minimal out of pocket expense at closing and many times there ends up being a short term gain in their cash position. This is due to a reset of their monthly payment schedule. Usually they "skip" a monthly payment, although the interest during that time period still has to be paid, usually by being rolled into the new loan balance.