By Douglas Katz – 12/07/2022
If you have not heard, mortgage rates have been trending up lately. This is an important consideration, but it is only one aspect of the pricing for a loan. In addition to the base rate which is more or less determined by market and economic conditions, pricing will be impacted by something called Loan Level Price Adjustments. These are add-ons to the price determined by the lender or the agency backing the loan and they are meant to offset risk for the lending entity. Some common adjustments are for property type, client’s FICO and down payment. One that people do not always think about is the transaction type, i.e. purchase or refinance. While not impactful on purchases, refinances, especially cash out refinances, often have add-ons for the borrower. These adjustments are not static and, as lenders see more or less risk, the adjustment will go up or down. Right now we are expecting to see the former at least for early 2023.
The Federal Housing Financing Agency or FHFA just announced that there will be an increase in the premium on cash out refinances to 75 basis points or 0.75% impact on pricing effective 1 February 2023. This means that any borrower pricing loans today would need to pay 0.75% of the loan amount in points on a cash out refinance to get the same rate before the bump or they would need to take a higher rate. Simply put, anyone wanting to tap their equity WILL pay more for the financing.
This is a very impactful change when looked at in the context of a few important scenarios.
- Renovation – Many homeowners, frustrated with the market, have decided to stay put and turn their current home into their dream home. For many, the only choice is to tap the equity in their home. While there are Home Equity Line of Credit (HELOC) and Home Equity Loan Options, which everyone should explore, these will have some unique risks and challenges that may make them a less desirable alternative to a cash out. If this is you, there still may be a tight but achievable window to get a fast refinance done before the changes hit. If you just cannot get it done in time to avoid the cost increase, you should immediately rereview your assumptions with the higher pricing. While not desirable, you may need to alter your plans and budget to align with the costs.
- Equity Buyout – Technically, an equity buyout is any situation where one owner need to compensate another owner or owners to take position of the home. In exchange for the buyout, the other owners release any claim of ownership. A prime example of this is divorce which is the most typical and sometimes the most difficult to execute. Now before addressing the cash out, there are some specific guidelines that allow for an equity buyout without a cash out transaction thereby avoiding a hit to the terms and pricing for the loan. EVERYONE getting a divorce should consult with a qualified divorce lending professional to develop a plan to keep the loan as a non-cash out transaction. When, however, there is no way around it and a cash out transaction is necessary, this pricing bump will come into play. The challenge with divorce scenarios is that they are often tight for approval and any change to the deal could jeopardize it. Any divorcing couple needs to determine what they can do and the impact on changes like this. Most Marriage Settlement Agreements have a required date by which the buyout needs to occur and a change like this can make doing so impossible.
- Debt Consolidation – Much the same as the renovation scenario, a cash out refinance often makes sense for debt consolidation where a homeowner can replace high interest debt with lower interest possibly tax deductible debt. The benefit is, of course, heavily dependent on the savings and the price impacts that. Usually, this type of deal will still make sense because debt like credit cards is also rising which offsets the increase in mortgage rate, but a re-review of your situation still makes good sense.
A final recommendation that would benefit anyone in any of the above situations is to cease any aggressive pay down of a mortgage loan. I have so many conversations with borrowers where I try to explain that equity is great until you need it and then it is expensive to access. In many cases, traditional savings, especially somewhere that provides interest, is a better place for the financial resources. It is much easier and cheaper to get the money when needed when it is not tied up in the home.
Regardless, this is a major pricing move by the FHFA and anyone looking to borrower needs to determine how this impacts their goals and plans. When you consider this and a generally rate increasing environment, the peril of having a much more expensive deal is a huge reality. As with anything choose your lender wisely and stay in contact. They are there to help.