Is the Refinance Boom Over?
This year, an estimated 1- to 1½ trillion dollars of adjustable-rate mortgages (ARMs) are scheduled to adjust -- upward. Many of these mortgages have been made to subprime borrowers, those who because of credit issues couldn't qualify for the best rates that lenders offered. An abundance of the ARMs are of the 2/28 variety; these mortgages offer interest rates which are 2- to 2 ½% above market rates for the first two years of the loan. This allows the credit-challenged borrower an opportunity to qualify for the loan at a more affordable payment. At the beginning of the third year of the loan, the interest rate adjusts and remains at the new rate for the remaining 28 years. Unfortunately, this new rate could be (and with the current steady rise in interest rates, very likely will be) substantially higher than prevailing market rates. This could serve to make monthly payments somewhat prohibitive, to say the least. These circumstances would seem to be poised to fuel the continuation of refinancing in this country, and most notably in California, where salaries have not kept up with rising home prices and borrowers are more leveraged on their mortgages than at any time in history.
One of the main advantages of the 2/28 ARM is that it permits the homeowner to develop a track record of positive mortgage payments, thus boosting his or her credit rating with the hope of refinancing to a lower fixed-rate mortgage before the ARM's interest rate adjusts. The prudent borrower will have used that time wisely to attempt to qualify for the lowest interest rate available. Although some still may not be able to qualify for a prime-rate mortgage, they should be able to obtain a much more advantageous fixed rate than the possibly nightmarish adjusted rate which looms on the near horizon.
Viewed from a somewhat different outlook, many homeowners will simply have no choice but to refinance out of their ARMs. Many borrowers that took advantage of initially-low-interest rate adjustable mortgages to hold down their payments during the early period of the loan are facing rate resets which could cause monthly payments to inflate by as much as ten- to fifty percent or more. Once these loans adjust, it's quite possible – and even likely – that many of them will no longer be affordable for the homeowners. For example, a $1 million mortgage (which is fairly common in California) taken out two years ago that began with payments of $2,500 could skyrocket to nearly $7,000 per month.
One solution, though extremely risky, that some of the state's homeowners are seeking is through the use of negative amortization loans. This form of financing allows borrowers to minimize their monthly payments while escaping the crushing burden of thousands of additional dollars that would be due from an ARM reset. However, this alternative is only a temporary answer at best, because the period that the loan will be allowed to negatively amortize is limited by the lender. Eventually, larger payments – much larger ones – will have to be made.
With California foreclosures up 160 percent since 2005, along with the sheer volume of ARMs due to adjust this year alone, the demand and need to refinance them will be extraordinary. Indeed, for the foreseeable future at least, refinancing will still be among us.