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I know several people who refinanced their homes to "save money", but I think they fell into the trap talked about in this write-up in the Dallas Morning News, borrowing money to pay off bills, only to charge up those cards again, or buy a new car. Lower interest rates doesn't mean you should refinance and borrow against your equity. Hope nobody here did that with good intentions, but fell back into the trap of "charge it to my credit card"...


Refinancing your mortgage can hurt instead of help
Betting against the house

12/30/2002

By DANIELLE DiMARTINO / The Dallas Morning News

Is the equity in your home going up in smoke?

A growing number of experts worry that this year's record rush of mortgage refinancings, spurred by homeowners seeking savings from lower interest rates, has actually left many in worse shape financially.

The culprit is cash-out refinancings – when a borrower takes equity out of the home as part of the refinancing. In some cases, experts say, homeowners are left owing more than the home is worth.

Cash-outs have exploded, fueled by rising home values and falling mortgage rates. Freddie Mac, the mortgage underwriter, estimates that over the last two years, more than half of refinancings have been cash-outs – when the loan amount rises by more than 5 percent.

"It's easy to see how lenders and borrowers could abuse this source of cash," said Mark Zandi, chief economist at Economy.com.

Studies show that the chances of a mortgage default triple when borrowers increase the amount of their balances by 20 percent or more. Citing those figures, Freddie Mac and its sister agency, Fannie Mae, recently announced additional fees for cash-out refinancings.

"They want to make sure people aren't leveraging up too much – especially in areas of the country where house prices have grown too quickly," Dr. Zandi said.

But higher fees may not be enough to dissuade homeowners lured by the equity in their homes, whether it's to put in a new surround-sound system in the family room, pay off other debts, or put food on the table after a layoff.

The cash raised in such refinancings nationwide has nearly quadrupled in two years, to an estimated $172 billion in 2002 from $44 billion in 2000. Economists say that cash has boosted consumer spending, which has remained strong despite the economic downturn.

"This helps explain the 'miracle' of consumer spending growth amid declining income levels," said John Lonski, chief economist at Moody's Investors Service in New York.

The boom


But Mr. Lonski and other experts warn that borrowing against your home and then spending the proceeds can be dangerous in a down economy.

As mortgage rates fell to historic lows, homeowners took advantage of the refinancing boom in a variety of ways. Some were able to go from 30-year mortgages to 15-year mortgages while keeping their payments the same.

Others replaced their 5-year-old mortgages with new 30-year mortgages, putting themselves in the position of taking 35 years to pay for their homes. In addition, many folded the closing costs back into the loan, increasing the amount they owed, albeit at a lower interest rate.

And still others refinanced their loan at a much higher amount and pocketed the difference, taking advantage of the increased equity in their homes from rising prices or upgrades they'd made.

The biggest beneficiary to the cash-out boom has been the home improvement industry. According to a study by Economy.com, 42 percent of borrowers said they were using the cash for home improvements; 30 percent said they would pay down other debt; 28 percent said they would buy appliances, furniture or cars.

Many in the home improvement crowd would like to think that they're not actually losing any equity in their homes.

But experts warn that dollar-in does not usually equate to dollar-out.

Craig Jarrell, president of Dallas' Pulaski Mortgage, says he plays the role of the bad guy when he has to tell someone they've lost a large chunk of the money they poured into home improvements.

"They just don't understand that the 50 grand they've added is worth only $10,000 – they haven't moved the house itself," he said.

"Did you get a new roof or a new fence? Well, great, so did your neighbor. Were you going to go without a roof on your house?" Mr. Jarrell asked. "You're just keeping up with the maintenance on the house. They're things you need and you are going to get a very low return on your investment."

The exception, he says, is an upgraded kitchen or bathroom.

They hold the greatest residual value when the time comes to refinance or sell your home, according to the National Association of Realtors.

Credit card debt


Many homeowners have taken what seems like the smart financial move of pulling equity from their homes to pay off heavy credit card debt. They still have the debt, but they're paying it off at a lower interest rate, and the interest now counts as part of the home mortgage tax deduction.

"Let's clean up the old balance sheet and start over – that's the poster child to use a home equity loan," Mr. Jarrell said.

He warned, though, that you need to take a good look in the mirror before approaching that loan officer.

Many people don't take the last step – cutting up the credit card. If you can't do that, Mr. Jarrell says, all it amounts to is "rearranging deck chairs on the Titanic."

Worse, it turns unsecured credit card debt into secured debt – if you can't make the larger payments, then you're in danger of losing your home.

"Let's say you are in a financially precarious position. Don't postpone the inevitable with a cash-out," said Jay Brinkman, vice president of research and economics at the Mortgage Bankers' Association in Washington. He says he's seeing more people pay off credit card debt with cash-out proceeds, just to run the bills back up again.

If you've suffered a layoff, taken a pay cut or run into some heavy bills, Dr. Brinkman says, at some point there may be only one solution: "Sell the house, take the equity out and reduce your standards of living."

Mr. Lonski of Moody's agrees and points to some disturbing data trends.

Two years ago, at the end of third-quarter 2000, personal income growth stood at 8.7 percent, while mortgage debt was growing by a similar 8.2 percent. By the third quarter of this year, personal income growth had fallen to 3.3 percent, while mortgage debt had roared to an 11.2 percent growth rate.

"These people may have more difficulty in making good on the money they owe, especially if they've increased their indebtedness to sustain a lifestyle they became accustomed to when they had a better job," Mr. Lonski said.

Cash-out cows


Texas law discourages cash-out refinancings. In Texas, you can't take out a mortgage for more than 80 percent of the appraised value of your home in a cash-out refinancing.

"If you've got a $100,000 house and you owe $75,000, the most you can borrow in a cash-out is $5,000," Mr. Jarrell said. "That just doesn't help most people."

But such restrictions do not appear to have dissuaded the masses. Dallas-area cash-outs jumped in 2001 and 2002. Estimates suggest that in 2002, Dallas residents will take $2 billion out of their homes – more than they did combined in 1998 through 2000.


Nationally, 2002 cash-outs are estimated to surpass 2001's record by 70 percent, to $170 billion.

The meteoric rise comes on the heels of a slowing in home price appreciation.

Freddie Mac's third-quarter Refinance Review suggested that it takes less enticing than it did a year ago to compel homeowners to refinance. The study showed that properties refinanced during the third quarter of 2002 experienced a median house-price appreciation of 11 percent during the time since the original loan was made. That figure is down from 18 percent growth for loans refinanced in the third quarter of 2001.

During the last five years, U.S. house prices have grown at an average annual rate of 10 percent. Now real estate analysts agree that the big run-up in residential values is waning.

And it's stalling more quickly in Dallas than in other parts of the nation.

During the third quarter, a midpriced home in the Dallas area sold for $137,000 – up just 2.1 percent from a year earlier, according to the National Association of Realtors. During the same period, nationwide home prices rose by more than 7 percent to a median of $161,800.

"Dallas has a specific problem with overbuilding," Dr. Zandi said. "More so than in the Northeast or California, homeowners in Dallas have to be more cautious with the equity in their homes – it is one of those markets where you're not going to make a lot of money off your home."

Unseen risk


In a cash-out refinancing, setting the home's value determines how much cash the borrower gets. That's an additional risk inherent to the process, says Frank Nothaft, Freddie Mac's chief economist.

When people buy a house, he explained, there are three different opinions that must converge as to the value of the home – the buyer, the seller and the appraiser.

"You have three independent estimates of the value of the home. Now, in a refinancing, you've got one person's opinion. You don't have these two independent corroborative views about the value of the home."

Critics compare some home appraisers to Internet stock analysts; they say both have boosted prices far above their true value by offering dubious opinions.

Don't want to pay private mortgage insurance, but you can't get an appraisal that puts you over that line? An accommodating appraiser may be just another phone call away.

Combine an easy appraiser with a crooked broker, and you've got a toxic brew for an unknowing homeowner.

"There are a lot of people out there trying to make a quick buck," Mr. Jarrell said. He has been active with the Texas Savings and Loan Department, which was developed a few years ago to regulate the mortgage broker industry.

At the outset, he says, they thought they'd be regulating about 5,000 licensed brokers. Falling mortgage rates drew thousands to the field, and today the number of licensees, who do not have to pass an exam, stands north of 17,000.

"Yesterday they were used-car salesman. Today they are in the mortgage brokerage business," Mr. Jarrell said. "They're preying on weakness and desperation to bail you out and selling you the wrong thing for a high price."

Statistics show that mortgage fraud growth has mirrored that of mortgage originations, which have peaked this year at nearly $2.5 trillion, according to the Mortgage Bankers Association of America. Mortgage fraud came in at just above $50 million five years ago; this year it may surpass the $300 million mark, according to the FBI.

Some worry that much of the fraud may still be hidden in inflated home values.

"The danger would be realized in the event that unemployment were to start moving higher – this would expose overvaluation in residential real estate," Mr. Lonski said.

"If real estate values fall, refinancings could make matters worse. You'll find yourself running the risk of having an outstanding mortgage that exceeds the market value of your home."

E-mail [email protected]
 

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Procrastination Racing
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Refinancing won't hurt you.
Mishandling your finances will.
You can not write off credit card interest. You can right off mortgage interest over time.
Credit cards are unsecured. A mortgage is secured. Many people would recommend leaving unsecured debts unsecured.
If you are not going to rack up misc debts then cash out refi at today's rates is a fantastic deal.
 

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EW, you're right...people will complain about anything, even if it's in their best interest.:confused: refinancing right now is a great idea, since the interest rates are so low, but banks can't be responsible for people's spending habits. to keep it simple, if you can't help but spend the money on things that you can't afford, then don't cash out on your equity when you refinance. that seems like a simple solution. this is almost like the people mad at mcdonalds because they are fat. people are always looking for someone to blame for their short falls.
 

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Discussion Starter · #6 ·
DamonH said:
I think that's the point of the article. Refinancing IS a good idea, as long as you do it wisely.
That is the point I got from it (doining it wisely).
It's easy to fall into the trap of revolving debt though, and with the option of borrowing against your equity, many people fall back into it.
For example, I know a person who owed less than 10 years on the current home loan. Refinanced for 15 to make the payments lower. Sure, it's less out of pocket each month, but that's an extra 5 years of payments too. I know everyone says, "But I'll pay extra and pay it off quicker", but it's too easy to make the regular payment and 'blow' the extra cash on something you've wanted.
 
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