Non-Owner Mortgage Refinance theory. Comments welcome.

A TI reader sent me a scenario that has it's plusses and minuses so I'm throwing it out for comments. I've seen these scenarios in the 2006-2007 mortgage market and several lenders are rolling out these again. What is listed below are not the actual numbers from this TI reader, but a reasonable analog to what was pitched by their lender. I've seen the same thing offered to a client on an owner occupied refinance as well by a "name brand bank".

Let's see what the crowd thinks!

Non-Owner refinancing is difficult to accomplish given how hard pricing is hit with add ons by the Agencies. Let's assume a couple of things:

1) The present value of the property is $800,000
2) The original loan balance is now paid down to 565,000
3) The original loan type was a 10/1 ARM at a rate of 3.750.
4) There are 5 years left on the fixed portion of the ARM.
5) The current payment is $2,778 (P+I only)

The owner believes that within 5 years rates will be considerably higher than where they are today. Even though 5 years are left on the loan, refinancing is being considered. At present, the offers on the table are as follows:

A) A 25 year term fixed rate refinance at 4.25 at zero closing costs (other than prepaids) Payment is $3,060 - remember, this is Non-owner, not owner occupied so those low rates being talked about just aren't there in this case.

B) A 25 year term fixed rate refinance at 3.250 at a new loan balance of $585,000 (+20k in points and fees). Payment is $2,826

In all 3 scenarios (keep the loan, refinance at no cost, refinance by adding fees) each of the loans will pay off in 25 years. The owner believes strongly that they will retain the property for at least 15-20 years.

Which choice might be is the wisest? Leaving the loan as is, yet stay awake at night fearing for the future? Is it best to keep your costs low and refi for peace of mind? Is it best to pay a higher fee today for the possibility of a lower rate in the future once the ARM adjusts?

What would you do?

My .02c

 

This is interesting because we had a similar scenario a few years ago.

Since it's non-owner occupied I would lean with the "as is" option but that also depends on the terms (index/margin/cap) once it goes to variable.

My second choice would be B. No money out of pocket for a rental.

Seems like an easy choice, B

If B, and for some reason there is a sale of the home in year 7-8-9 or so of this scenario, the loan payoff balance would higher than scenario A or leaving the loan as is. How certain is ownership over the expected period of time? Hard to know. Although this owner believes they will keep the property for an extended period of time, shouldn't this too enter into the decision process?

My .02c

option b if they need to decide today.

but how much lower can rates go in the next 3-6 months if we continue on the same trajectory?  are you advising an option c, which assumes we see another 25-50 bps drop?  is that unrealistic?

I would recommend waiting to see if rates drop after the next Fed meeting on Sept. 18th and go with option B if they are wanting to refinance.
I don't ever recommend paying points upfront to save on the monthly payment.  What if the owner end up not keeping the home for as long as expected?  Plus you would have to factor in the breakeven point if they go with option C which would take them over 7.5 years just to recoup the upfront cost before the real savings start.

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True, but there is no guarantee that when the Fed lowers the Discount/Fed Funds rate that mortgage rates will rise or fall. The two are not connected. In some cases when the Fed cuts rates mortgages pop higher since either the Fed isn't doing enough to tame inflation, or the Fed is doing too much to prompt inflation which is bad for mortgage bond holders.

Waiting raises the question "am I missing a once in a generation opportunity to lock in a very, very low rate". (Spoiler Alert: no one knows) As well in this case the TI poster is genuinely concerned about the direction of rates in the coming years. I've said often on this board "There is no price for peace of mind" and in this case, peace of mind is not "risking" it with an ARM. Risk, like tolerance for hot sauce, is relative. What might be easy to splash on chicken wings for some, while for others even tableside pepper is too hot. This TI poster is uncomfortable walking the halls at night wondering if the ARM, like a grenade, has the pin pulled and the critical time to throw it away is unknown.

Personally speaking, I'd keep the deal and not refinance. My risk tolerance is higher than most. I can also tolerate some chopped Habanero in my food, but in both situations that's just me and not the person struggling with the refi decision.

My .02c

So if the person is more worried about stability and less worried about cash flow, A would seem to be the choice.

Soylent, you are in the business, so when is the slowest time for banks, in term of mortagage purchase and refinance?

Beside the weak global economy and trade war drags, plus the the cross hair for the slow time for banks transactions on mortgages, would that be the time to pull the trigger?

Not a for sure thing, but just alligning the ducks for best result.

Thanks for asking.

There isn't a "slow time" per-se. Mortgage Lending has basically three business lines - refinancing, purchase loans, and HELOC's. When rates are high, refinancing is slow. When resale homes aren't selling (January-February) purchase loans are slow. During slow resale purchase volume, sometimes production gaps are filled with builder loans that close as phases are completed during the Winter. When people need cash (all the time, it seems....) HELOC's can be made.  Each business line has its own trend line and production gaps are filled or drained according to financial conditions that cannot be charted.

If I had to commit, the slowest time for lenders - big or small - is when we see rates above 4.75%. That's been the lenders range for the past decade. Anytime fixed rates are above that 4.75 level, phones quit ringing for refinances and purchases fall by 20%. It's the 'blood in the streets' moment smart money waits for, to swoop in and buy homes while owners are not getting their price. Most of that street blood is from refinance jockey's with gutted pipeline volume, those who expected a refi boom to last forever. We all know nothing does.

My .02c

And that is the case of attempting to time the rate low and jumpin? for refi, isn?t it? If rate is at 4.75, what would be the point for refi when my current rate is much lower than that of 4.75. Sound counter intuitive to me, or I am not reading you correctly.

Option D, are the 30 year numbers the same?  It's a rental yet the owner is holding on to the payoff term the original loan.  Ideally, option B on 30 year becomes locked in with lower P&I improving cash flow.

Otherwise, I too favor Kings option C.  My personal bias, you don't refinance and inrease your payments except to avoid much worse payments.  JIMHO, with potential recession, global recession, BREXIT global f-ckery happening and 5 years on the term, I wouldn't lose sleep.

CV - Seems like I didn't understand fully the question. There isn't a slow time, only when rates rise. It's impossible to time the market, but you can get fairly close. For ARM rates, it's difficult to see rates below their margin. Most ARM margins are 2.25%. If you can get an ARM between 2.5 and 2.25 you've done well. The last bottom in rates saw no cost 30 fixed rate refinances at about 3%. That rate existed for only a tiny window of time, then popped higher. If you can get a refinance rate for a 30 fixed loan at or below 3.125, you've done well for yourself.

Could rates go lower? (Shakes Magic 8 Ball) "My sources say yes".

Is it likely to mistime the bottom and not capture the very lowest, low rate? (Shakes Magic 8 ball again....) "Absolutely".

Hope this helps.

My .02c 

NSR, we're using the original post as a "frozen in time" example of pricing.

Fixed rates are always higher for non-owner purchase or refinance than their owner occupied counterparts. In many cases Non-Owner ARM loans for either purchase or refinance are higher than fixed rate options. Investors in MBS's are loath to buy Non-Owner ARM portfolios at present.

My .02c

I get that, but my question is specifically loan term.  In option be, is that rate the same as for 30 year term.  Same question on points, fees etc. The P&I will be lower.  The trade off is what percentage of the property they own today, versus at refi, five years in, twenty five years in (paid off versus last five year of mostly P in the P&I.

My main point is all scenarios presented, increase payments or payments and balance.  With a five year horizon, to me that's a slightly irrational fear driving the decision.

Mortgage Backed Securities are often pooled in 30, 20, 15, and 10 year increments. In a situation where there is an odd year loan (25, 17, etc) the default is to a 30 or a 20 year MBS. The loan is then a 30 year rate, structured to amortize over 25 years.

Rates vary a bit from a 30 to a 20, usually by an improvement of .125 percent.

My .02c

Thank you, good to know.  Sounds like a weed out question for mortgage brokers going forward when I get the BS answers on that.

Great, write option B as option E with a 30 yr term, 3.25% rate and $2546 payment.  Pocket the $250 per month, make a additional $250 equity payment and reserve the flexibility for owners discretion.

(edit:Amazon can stuff their updates and inept autocorrect and intrusive processes that cripple the device)

What are the caps on the existing 10/1 ARM loan?  Is the "non-owner" status a second home or investment property?

It might help if you modeled out the worst case scenario for years 11-20 so they could see what the actual risks are, and keep in mind that if it's an investment property, the higher the interest rate the more they can deduct on taxes, limiting the damage of higher rates by the percentage of their combined Federal + state marginal tax rates (likely 33.3% or higher).  So a 1% increase in rate is really only 0.67% (or less) after tax.

Without full knowledge of the situation, my answer is the same as yours... With 5 years left before their loan adjusts, do nothing.  Or at least wait until we reach the bottom of the rate cycle during the highly anticipated next recession.

Liar Loan said:

What are the caps on the existing 10/1 ARM loan?  Is the "non-owner" status a second home or investment property?

It might help if you modeled out the worst case scenario for years 11-20 so they could see what the actual risks are, and keep in mind that if it's an investment property, the higher the interest rate the more they can deduct on taxes, limiting the damage of higher rates by the percentage of their combined Federal + state marginal tax rates (likely 33.3% or higher).  So a 1% increase in rate is really only 0.67% (or less) after tax.

Without full knowledge of the situation, my answer is the same as yours... With 5 years left before their loan adjusts, do nothing.  Or at least wait until we reach the bottom of the rate cycle during the highly anticipated next recession.

Click to expand...

+1 Totally agree, stand pat and see how things play out.  I'm sorta in a similar situation with a 2.625% 7/1 ARM with about 4 years left to go.  I'm honestly in no hurry to refi because I think rates are heading lower in the near term.  When the 7/1 ARM is around my current rate then I'll refi.

Good points. ARM indexes are going to change soon from LIBOR to who knows what. Initially the change won't be significant, perhaps lower in term just to keep everyone happy. For now, let's assume the following:

1) In year 10 of the loan (5 years from now) the balance would be about $460,000

2) Using a 2.25 Margin, most fully indexed ARM rates would hit 4.5% or so if their first adjustment was to occur today. (1yr LIBOR is 2.20%)

3) Worst case is a 5% adjustment from the initial rate, or 8.75%

When the loan adjusts it's now a 20 year repayment loan.

The current payment is $2,778

In scenario 2, the new payment would be $2,910

In scenario 3, the new payment would be $4,065

I tell all my clients considering an ARM loan to "Plan for the worst case, but remember than in X years, your income won't be where it is today". Think about this scenario in your own mind. 5 years ago the payment started at $2,778. In 5 years it might rise to $2,910. It could if everything goes to shiat zoom up to $4,065. Where does the reader think their income will be in 5 years - not the rate, as we know the worst case - but the income you might be living on?

This scenario also assumes no prepayments along the way, and for now a constant rate of rental income. If you rented this home on a break even, your net costs might rise, but might rent change as well?

A thousand different variables produce an infinite number of futures to ponder. This TI reader is concerned about the 'now' and wants to move on what they see it a good way to preserve a low payment. I personally do not agree with adding $$$ to a loan balance as these other lenders are recommending. That said, my risk tolerance is higher than most - for other's it's not. There are intangibles at play (peace of mind vs $$$) to consider.

Hope this helps answer some of the earlier post questions.

My .02c