HARP and Traditional Refinance

Refinancing your mortgage may seem ideal and particularly pressing when you are contacted by a “HARP specialist” anxious to point out that the rates are better than ever and the deadline to apply fast approaching. If you are considering such a move, let us first check to see if refinancing makes sense AND if you even qualify for or should use the HARP program.

Let’s begin by reviewing when and why we would take the time, make the effort, and incur the cost of a refinance. Refinancing is often done with the intention to lower interest paid, lower the monthly payments, or to change the terms of the mortgage. You may not realize that refinancing also restarts your amortization and could cost you in hidden ways by having you pay more interest over the mortgage period. A refinance is really a new mortgage where the new mortgage pays off your old mortgage and you work with the new product. The refinance may be ideal for the lender, but not always appropriate for you.

Traditionally refinanced mortgages are either for the balance of the previous mortgage OR for a higher balance by taking cash out. These are referred to as a “simple” or a “cash out” refi. Every time you do a refinance, your finances have to be in tip-top shape and you must select the right lender. Too often clients, for convenience, will use their current bank to refinance their mortgage, which may not offer the best terms or the easiest process. Regardless, you will be asked to verify your income. Moreover, you must have at least 20% equity (home-to-loan value, or LTV) if you don’t want to pay the mortgage insurance. The process for ALL refinancing will require that you gather documents and find the right lender, then submit an application, which the lender must respond to within 3 days with a good faith estimate (citing all costs). Once you accept, it may feel like ‘hurry up … and wait’ since the lender now has 2-3 months to respond. They will often come back to you for more information or clarification, so it turns into a back-and-forth experience. Eventually, you’ll lock-in a rate for another 30 days while verifying the final paperwork.

In the 2008-9 crisis, properties were valued lower (in most areas) and in some cases homes were worth less in the market than the mortgage debt (i.e., “underwater”). Since this was only a paper lose, it was only a problem for families with high-rate mortgages, an immediate need to sell, and with strained budgets. Sadly, these home owners were often denied a refinance to take advantage of much lower interest rates, reduce monthly mortgage costs or provide a more stable fixed-interest mortgage. It was to address this stressful financial situation that several programs were created. One, discussed below, is the HARP program.

“HARP” is the Home Affordable Refinance Program, a federal-government program established after the last housing crisis to assist homeowners with refinance (at today’s lower mortgage rates) even if their current mortgage is underwater. The goal of the program is to allow borrowers to refinance into a more affordable or sometimes a more stable mortgage product.

The HARP program ends December 31, 2016 and, as happens often before a deadline, we find an increased flurry of lenders trying to convince every home owner that they are the ideal candidate for this government program. HARP mortgages are not for everyone.

The first version of HARP had too many limits and in 2012 the HARP 2.0 program was created eliminating some of those limits. Notably, the underwater limits were removed, appraisals no longer needed, the refinance process streamlined, some fees for being ‘underwater’ eliminated, and allowance made for less stringent verification of income (to include not just W2 statements but also 12 months of saved mortgage payments).

The biggest difference between the traditional and HARP mortgages is that you don’t have to have an LTV ratio lower than 125%—the HARP program eliminated this limit. You could obtain a lower rate mortgage even if your home is still worth much less than your own mortgage.

As I’ve stated, HARP is often used to reduce mortgage interest and reduce monthly payments, but others use HARP to convert adjustable rate mortgages (also referred to as ARM-loan) into a more predictable, fixed-loan program (usually 30 years) or if it fits within your budget, a 15- year mortgage that helps you build equity faster.

HARP was never intended for individuals who are near bankruptcy or who have not paid or can’t pay their mortgages. Rather, it is intended for those who have managed to stay current on their mortgage payments, and yet, are not able to change to lower rates since they no longer qualify for a traditional refinance either because of lower income or decreased equity.

In my experience, HARP is a difficult option to pursue because the home owner not only needs to be current on their mortgage, the mortgage needs to be under Fannie Mae or Freddy Max and therefore must be “conforming.” Conforming loans have maximum limits of $415K to $625.5K depending on the location of the single family dwelling. Most Bay Area homes have mortgages that easily exceed these values. They are also only valid if the mortgage was acquired by Freddie Mac or Fannie Mae before June 1, 2009 (an arbitrary date stemming from the crisis).

Because the regulations are rather document heavy and include many exceptions, some lenders have adopted their own versions, so you may need to change your lender to obtain the best HARP loan. Even though the process was to be streamlined, implementation fell far below expectations. The lender’s representative often lack enough knowledge, causing a great deal of frustration to an already stressed individual/family. For example, clients thought they had to use the same lender and that it only applied to their primary home—this is not the case. You can use any lender and HARP can be used on any mortgage that is backed by Fannie Mae and Freddie Mac. The goal is to support those underwater because of the 2008-9 crisis.

Regardless of whether you are considering refinancing through HARP, other government programs or a private lender, you must always examine the total costs AND the purpose for the refinance. If you’ve recently completed a refinance then you need to have a really compelling reason before considering yet another refinance. If you need to increase cash flow then look for low closing costs but expect you’ll pay more interest in the long term. BUT if your purpose for the refinance is to cash out equity or to change some other aspect of your mortgage, then the upfront closing costs may be acceptable. At times, clients appear interested in refinance every few years largely because of lender contacts or advertising. Refinancing every few years can be a costly mistake. It is important to remember that each time you refinance you are starting with a brand new mortgage which will restart the amortization. Restarting amortization is good for the lender, but, not always good for you.

There are a couple of lessons here. First, to truly take advantage of opportunities like HARP you need to be on top of your finances. You also need to understand the product/plan that is offered. Ask yourself is this good for my financial situation? If unsure, drops us a line and we’ll check out the product and provide you with a product neutral opinion that is appropriate for your financial plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

When does it make sense to payoff your mortgage before retirement?

It is relatively easy to make paying off your mortgage a goal, largely because you think it will “feel good” or because you imagine that it will be “liberating” to throw a mortgage burning party. But be careful that you are not mixing a critical financial decision with an emotional reaction. It may seem illogical, but there are many reasons why it is sometimes a better financial decision not to pay off your mortgage. That said, there are also some very good reasons for paying off your mortgage prior to retirement. The balance is often tipped by the amount the client spends on their lifestyle budget, the amount they have saved in available non-home assets, their tax liability, the source of the money used to pay off the mortgage and what they have decided to do for unexpected expenses.

For most of our clients, a mortgage on their principal residence is a low-rate loan that can be used (since 1997) to reduced tax liability (usual tax refunds drop the effective mortgage interest rate by as much as 1-3% for our clients). A mortgage repayment is stretched out (amortized) over a long period of time (15 or 30 years are common) with most of the interest paid during the first 2/3rds of the amortized period. When combined with inflation and a healthy appreciation in real estate valuations, a mortgage provides the buyer an opportunity to expense a very low cost loan while building equity in the home with money that would otherwise (at least in part) go toward rent. A mortgage loan can also be used to maximize and grow savings pre-retirement, obviously freeing clients to use these savings later while in retirement. The argument can also be made that a diversified portfolio started with assets that might have been used to pay off a mortgage (though not guaranteed) can yield a rolling average of 6-9% (with a margin of safety) and provide assets that grow above the mortgage rate and that are available for use outside of the home asset.

Many of our clients will have reduced or no earned corporate income during their retirement years, and plan to rely primarily on portfolio, pension, and social security to support them for 30-40 years. During this time they might have lower taxable income, but that is only true if their lifestyle expenses are low enough (something that is difficult to do in the Bay Area). If not, they might increase their taxable income to support their lifestyle and would benefit from available tax deductions (including mortgage interest). Most of our clients would like to remain in their homes throughout retirement, but this adds a further complication if they do not have enough non-home assets to support their annual budget. We find that home owners are surprised that they can’t tap most of their home equity (at reasonable costs) until they sell their home.

Paying off a mortgage is sometimes worth considering when the client has sufficient assets to support retirement outside of (i.e., above and beyond) their home. As an example, consider someone with a lifestyle expense in retirement of $100K annually (after social security). We can roughly estimate that they will need about $3M in portfolio assets to support their lifestyle and to ensure that they will not be forced to sell their home to support themselves. This $3M is only an estimate since it may not be sufficient if there is no supporting plan to cover unexpected expenses. But assuming there is sufficient savings and buffer, paying off the mortgage becomes a viable option which would reduce lifestyle budget (since there should be no mortgage payments) and tax liability.

Since several clients would like to hear scenarios that highlight the advantages of paying off their mortgage prior to retirement I’ve outlined two below:

1)  When a client plans to live in a mortgaged home until they need care, have low lifestyle expenses AND enough money outside of their home asset to support their lifestyle budget, including maintenance of their home. In this situation (particularly when their tax rate will not benefit greatly from remaining Schedule A deductions) the reduced expense derived from not paying a mortgage provides measurable benefit and real financial freedom. In addition, leaving a home with little or no mortgage is popular with those who wish to provide a legacy. However, clients have to be prepared for a potential increase in taxes in retirement particularly if they need to draw more from their portfolios. There is also the possibility that they may need to sell their home to unlock equity to cover unexpected expenses.

2)  Another scenario that encourages paying off the mortgage pre-retirement applies to clients with a low taxable income, sufficient non-home assets to support their lifestyle expenses and a sudden influx of cash to cover their mortgage (this cash must be more than the amount they can contribute in a tax advantageous manner and not needed to support their lifestyle).

It has been clearly demonstrated that anyone with a fully diversified portfolio benefits most from maximizing tax-advantaged savings prior to retirement. Usage of funds that could be contributed to these types of accounts to pay off a mortgage often results in too much home and not enough cash (house rich, cash poor, as the saying goes). This is particularly the case in areas where home appreciation is high and home equity grows, but can’t be accessed cost effectively. A misconception is that a large mortgage is the best way to reduce taxes because you can minimize them through Schedule A deductions. This is patently not true. The best way to minimize your taxes is through tax-deferred savings, not deductions. Do note that in retirement, neither tax deferral nor the option to obtain a mortgage at a reasonable rate may be available.

Each person needs to consider the best way to manage their mortgage payments in retirement. In this article, I have sought to help you recognize some of the key components that factor into whether it makes sense to pay off your mortgage prior to retirement. It is important that you realize that there is no single answer for everyone and that we must balance your budget, taxable income, amortization period and plan to cover contingencies during retirement before making this decision.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What do you do if your mortgage is denied?

How do you prepare for a mortgage application? What do you do if your mortgage application is denied?

As of August of 2011 lenders rejected about 50% of received applications for mortgage refinance (according to the Mortgage Bankers Association).

We recommend to always know and improve your credit history before you apply for a mortgage or refi. – the key is to improve your credit score.  If the mortgage is still rejected then we look at the lender – was this because they are the wrong type of lender or is there something else going on?

Why might you not qualify for a mortgage?

If your mortgage application is denied, always find out exactly why the lender turned you down.  The law states that you have the right to receive a disclosure letter – but you want more than those general letters – so use the fact that you have the right of disclosure to find out the ‘real’ reason from the front person you worked with.

The best way is to take the disclosure letter to your loan officer and ask for an explanation that makes sense to you, something that you can do something about.  The front person is a great source of answers as to how your loan is perceived at that institution.

What reasons are there for rejecting a mortgage application:

1) Appraisal was too low to back the amount of loan requested – declined due to LTV (loan-to-value). Lowball appraisals kill many purchases and refinances, but if you are certain that it is a low appraisal it is worth reapplying with a different lender.  Try to find a mortgage lender that is local and uses local appraisals to ensure that they know the market value for your home.  One of our clients had an appraisal at $1.2M and yet it came in at $2.1M with a local appraisal – not a small discrepancy between appraisals!

2) Credit history problems should always be resolved before you apply because some credit fixes can take time (6-12 months).  If your credit score is slightly lower there may be quick fixes like paying off credit card balances but even they will take 3 months before they show up in all three credit scores.

Some lenders will do a rapid rescore to get a new score soon after you know that the three credit history companies receive your changes – but this can still take time.

3) A too high Debt-to-income ratio will require that you pay off debt so that your monthly payment obligations are low enough compared to the income you earn.  Although unusual some times we find that clients have not included all of their income. In most cases, we help clients select the best assets that will be sold to pay off debt and lower their monthly debt payments.

Most lenders follow Fannie Mae (45%) and Freddie Mac guidelines some have more stringent requirements (35-38%).  Forty-five percent is a very high DTI and we recommend that despite the allowed DTI you not exceed 35% DTI.  If you are trying to get a mortgage with a DTI above 35% consider carefully if you have the capacity to maintain this debt load if  you have an emergency or unexpected financial shortfall.

4) When selecting your mortgage consider the size of the lending institution.  Often we find that community banks and credit unions have more flexible underwriting standards.  This is particularly important for those who are self-employed.

5) Do not take mortgage rejection personally.  At times it is not ‘the right time for you’ to refinance or purchase a home.  It will be the right time for you if you take the opportunity to manage your finances, pay off debt responsibly and keep adding to your earning history.  Always get your finances in order 6 to 12 months ahead if you are planning to buy a home.  For many, this is their largest debt they will obtain in their lives.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Judge Criticized SEC and Rejects Citi’s Mortgage Settlement

Judge Calls SEC on Allowing Settlements that do NOT address liability

— Content from Bloomberg and SEC websites

At question was Citigroup Inc.’s $285 million settlement with the U.S. Securities and Exchange Commission over mortgage-backed securities.  The federal judge rejected on grounds that he does not have enough facts.

U.S. District Judge Jed Rakoff in Manhattan rejected the settlement – he criticized the SEC’s practice of letting financial institutions such as Citigroup settle without admitting or denying liability.

The SEC claimed that Citigroup misled investors in a $1 billion fund that included assets the bank had projected would lose money. At the same time it was selling the fund to investors, Citigroup took a short position in many of the underlying assets, according to the agency.

Citigroup, the third-biggest U.S. lender, agreed last month to settle a claim by the SEC that it misled investors in a $1 billion CDO linked to subprime residential mortgage securities. Investors lost about $700 million, according to the agency. A trial could establish conclusions that investors could use against Citigroup.

“In any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth,” Rakoff wrote in the opinion. The proposed settlement is “neither fair, nor reasonable, nor adequate, nor in the public interest,” he said.

Danielle Romero-Apsilos, a spokeswoman for Citigroup, declined to comment pending a review of the decision. SEC spokesman John Nester declined to comment immediately on the ruling.

Rakoff today consolidated the case with another SEC suit involving former Citigroup employee Brian Stoker and scheduled the combined case for trial on July 16, 2012.

Citigroup doesn’t want to formally admit liability because of the bad publicity that would follow and because an admission would give a powerful tool to investors suing the bank.

Allowing a bank to pay a fine without admitting liability allows the SEC to avoid the uncertainty of a trial and preserves resources that can be used to pursue other securities law violators.

He rejected the SEC argument that he should defer to the agency’s determination that the settlement is fair, particularly as it asked him to issue an order requiring Citigroup not to violate the securities laws in the future.

Calling Citigroup “a recidivist,” Rakoff said the SEC hasn’t tried to enforce such an order against a financial institution in the past 10 years.

Bloomberg News and SEC response at http://www.sec.gov/news/speech/2011/spch112811rk.htm

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Tax: First time home buyer credit

First Time Home Buyer Tax Credit and your 2008 tax withholdingsAre you eligible?

This tax credit is limited to those with an adjusted gross income (AGI) of less than $95K and $170K (single and joint filer) and who buy a personal residence between April 9, 2008 and July 1 2009. The credit is disallowed if the property is no longer your principal residence before the close of the tax year. It is also disallowed if you are classified as a nonresident alien, or your financing is from tax-exempt mortgage revenue bonds. You must be a first time home buyer which is defined as having no ownership interest in a principal residence during the three prior years. You must be a US citizen or US resident alien.

How much and how will you receive the credit?

The maximum amount for any Home Buyer Tax Credit is $7,500 and it is a refundable credit (which means that you will get the credit even if you don’t owe taxes). If you owe $5,000 and your credit is $6,000 you will receive a check for $1,000. It phases out at $75K and $150K (single and joint filers). You will receive the credit when you file but if you qualify you may adjust your withholdings or estimate taxes to accommodate this credit.

What is the catch?

The biggest catch for Bay Area home owners is that most do not qualify. If you do qualify for many home purchases you often need to earn enough to cover a fairly large mortgage which will, in many cases, place you above the limits to claim some or all of this credit. In addition, this is not “free money.” It is a 15-year no interest loan that must be paid back at $500 per year.

What should you do?

First determine if you are likely to qualify this year or early next year. If you do qualify, then consult with your tax planner or accountant and adjust your withholdings or estimated taxes either this quarter or early next year.
For the original documents, check the links on our resource page: www.aikapa.com/links.htm

** Please note, this is a Financial Bites column provided for general use by our clients — always check with your tax planner or accountant **

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com