Financial planners answer your questions: How to refinance when your home has lost value

We’ve pulled together some of Atlanta’s most respected certified financial planners to answer your questions each week. Do you have questions about credit? Want to know how to better manage your finances? How to save for emergencies? Plan for aging parents? Save for retirement? These questions and countless others will be handled each week by a group of pros.

Today, Cass Chappell from Chappell, Mayfield and Associates answers a question from Tammy of Stone Mountain

Cass Chappell

Cass Chappell

Q: I have lived in my home since 2002 and currently owe a first and second mortgage.  The first mortgage is financed through an online bank which doesn’t offer 30-year fixed rates (only five- or seven-year mortgages).  My first mortgage has recently renewed so I have one year at a rate in the 3 percent range.  I have excellent credit and should have no problem qualifying for a new mortgage but the value of my home is my biggest hurdle against refinancing.  Because my home is located in a “depreciating market,” I am unable to simply requalify for another five- to seven year term.  I have attempted to refinance once (in 2009) only to find that the value of my home is too low now compared to what I owe and need to refinance.  I was advised by the online bank that I’d need to consolidate my first and second mortgage, which would mean coming up with several thousand dollars that I don’t have access to unless I pull money from my retirement account.

What advice would you offer someone like me who doesn’t have enough cash on hand to pay down my mortgage so I can refinance, but is stuck in limbo with the bank in terms of fixing my rate or refinancing my mortgage?

My second mortgage is not a problem because I financed through a credit union and only owe for five more years.  I would like to lower that interest rate as well but the first mortgage is what I’d like to secure first.

A: Your question is a very common one. There are a number of variables that go into making this decision.

First, 3 percent is a very good interest rate. Even with your good credit, it is highly unlikely you could secure a 30-year mortgage for anywhere close to this rate.  This rate is now variable (since your fixed period has expired).  As I am sure you are thinking, just because the rate is great now doesn’t mean it will stay that way. If rates return to their long-term averages, you could be facing a much higher interest rate in the future.

Most variable rate mortgages have a maximum amount that the rate can increase from year to year, as well as a cap on the amount it could go to during the life of the loan.  A provision like this might be 2 percent maximum in any one year, and 10 percent for the life of the loan. So, in a high interest rate environment, someone who had a loan like that would see their interest rate go to 5 percent, 7 percent, 9 percent and then 10 percent (the cap). This is a form of protection for you in the event that rates go much higher.

In other words, it would likely take a few years of high interest rates for your mortgage to catch up.

It is not uncommon for us to see folks whose rate went down at the expiration of their fixed period. I would venture a guess this happened to you, too (3 percent seems below any prevailing fixed rate in 2002 – when you secured this loan).

If your fixed rate was, say, 4.5 percent, then your payment has now gone down. I would recommend you continue paying the same thing you were paying prior to the reset. This way, you will be paying extra principal each month. By reducing the outstanding balance on your mortgage each month you will be lessening the negative impact of a future interest rate increase.

For example, owing $200,000 at 3 percent is roughly the same as owing $100,000 at 6 percent.

Take advantage of the3 percent rate by paying as much as you can towards the principal. Don’t stop saving in your retirement plan, though!! And I would plead with you not to take money out of your retirement plan to pay refinancing costs.

By not refinancing, you are taking a risk.  Interest rates could go higher. But, with ample cash flow to continue your old payment (and thus accelerate your principal reduction) in conjunction with provisions that would prevent a huge increase in your rate in any one year, this could be the right play for someone in your situation.

Since you are reducing the principal on your first and second mortgage, it shouldn’t take long for you to qualify for a refinance (if you decide you don’t have the stomach for this risk).

Be careful to continue paying your old payment. Once you’ve paid off the second mortgage (5 years) put that payment toward this loan. At that point you could be quickly heading towards a debt free situation — my favorite kind!

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