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Ask the Readers: Ethics and Lowering a Mortgage…

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Today, I'd like to feature an email from a reader. With your help, perhaps we can guide her to making the right decision for her.

Nicole writes:

"My husband and I own a duplex that we bought three years ago that is strictly used for investment and because of our interest rate that is almost at 7%, we are looking to refinance.

However, these are the problems that we are faced with. When we called our bank to possibly refinance we found that they are willing to do it, but not at the prime rate. Because it is a rental property, the interest rate will still be a bit higher that prime, but still a 1% lower than what it is now and saving us about $120.00 a month.

Well, then through conversation, we realized that the LTV (Loan-to-value) was 80% and the PMI would be dropped, saving us another $91.00/mo. However, with their steep closing cost, (again due to it be an investment property) that they add that in to the new refinanced mortgage, that would take us back to the less than 20% invested to have the PMI removed. SO, we then asked them about just doing a rate modification, which would save us on closing cost, get our rate lowered and also allow us drop PMI. In order to do so, they gave our information to a mediation company that will lower our rate to 3% for the term of the entire loan, making our mortgage payment 700.00/mo including everything, bringing in an extra 1000.00/mo The catch is we would have to stop paying the mortgage for 2mos. while they attempt to prove a hardship. Is it worth the gamble and is it worth defaulting and hurting our credit? We are really honest people, who, for the most part, play by the rules. We feel we are getting the short end of the stick. Do we take advantage of this opportunity the way the rest of the world has?"

[Note: I've cleaned up some of Nicole's informal email for grammar, spelling, and formatting for posting here...]

Before I give my thoughts on Nicole's situation, I should clarify a few things. It's been 4-5 years now since I've done anything mortgage-related. I've simply been making payments each month. Additionally, I'm not licensed to give financial advice, so I will give more broad commentary on what I might do.

Nicole's situation is a little closer to mine than most questions I receive. For instance, my wife and I both own investment properties. The difference is that we didn't buy them strictly for investment purposes and are rates are at or below 6% - locked in for 30 years. While we have noticed some lower rates out there... as Nicole mentions since it's a rental property, we aren't likely to get the lower rate and save any money by going in that direction.

The most interesting aspect of Nicole's question comes from the advice she received to stop making payments to prove a hardship. I had a friend tell me that it was possible to do a similar thing. That led me to write about lowering your interest rate without refinancing. There I openly wrote about the ethics problem I had with the idea of fabricating a hardship. My rationale in the comments was that people who were doing the wrong thing were coming out in better situations than I was. I often pretend we live an ideal world, where people doing the right things are rewarded... when that doesn't happen it tempts me to the dark side. Fortunately, I realized this and decided not to go through with it. Part of my rationale was the old adage that two wrongs don't make a right.

I don't want to impart my ethics on Nicole, so I won't. She seems to have an idea where she stands with comments like being honest people and playing by the rules. If she does decide to go the route of proving a hardship, I'd take caution. It sounds like she's getting a shady offer that's not going to be put in writing. My experience with such offers is that they tend to disappear. It reminds me of a game of chicken where she is hoping that by continuing forward she'll reap the rewards of a much lower rate. The downside is an ugly crash that ends with bad credit and not being able to improve on her 7% rate at all.

Personally, I'm very much the chicken who would take the small gains rather than risk it (especially with the ethics involved). I would try to find a bank with fewer closing costs. That's always a nice, but not realistic option. Secondly, I would suggest living extra lean for a couple of months so that they can get under that PMI. Perhaps most realistically, do the refinance to knock it down to 6% under the condition that the bank will agree to drop the PMI when they get the loan amount under a certain number. The reason I would get this in writing is that you don't want the bank to turn around and drop the value of the home, keeping the LTV above 80%. This would still save her over $210 a month and seems to come with no risk.

What do you have to say?

Posted on May 11, 2010.

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18 Responses to “Ask the Readers: Ethics and Lowering a Mortgage…”

  1. Kyle C. says:

    I would also caution them on this game they are talking about playing. There is no way someone is going to put an offer like that in writing because it would prove that you were gaming the system and didn’t actually have a hardship. Add in to the whole equation the extra costs you will pay on any future loans you would take out and I don’t think you are really getting any benefit.

    If you default on your loan now it is going to affect your ability to get good rates on say your primary mortgage, or a car loan, or anything else in the future. Employers look at your credit too, are you going to explain a prospective boss that you didn’t really default, you were just trying to game the system for a better rate?

    These are things you don’t think of and the lender won’t tell you about, honesty is the best policy.

  2. Any chance of getting a piggyback? For example, if 83% of the value is owed, 80% at the lower rate and 3% in a ssecond mortgage at a slightly higher rate?

    When we bought our house, we did an 80-10. The spread between the rates on the first and second mortgages was a quarter of a point. My wife and I both have accounting backgrouds and immediately figured out that this was substantially cheaper than PMI. Not only that, but the cost decreases each month (esp if you put extra money toward the 2nd mortgage).

    I’m not sure if a lot of lenders are willing to do this, and the ability may have tightened in the last couple of years.

    Luckily, when we refi’d a couple of years ago, the value of our house had actually increased.

  3. Ron says:

    Sounds like they need to increase the V in the LTV. If it’s so close that closing costs would put them over that magical 80%, perhaps a different appraiser or some cosmetic upgrades would help. Banks are pressuring appraisers to be very conservative with their numbers so they should make sure the appraiser has all the information on what makes this property more valuable.

  4. Stephan says:

    as i am clueless about this, just how much extra does PMI add? and is it standard for it to be for anythign less than 20%?

  5. jim says:

    I wouldn’t default.

    It doesn’t really sound like they are in a hardship. If they aren’t in hardship then I wouldn’t default in order to attempt to prove hardship. Plus doing so will trash their credit which has other negatives like higher insurance rates and consumer credit rates.

    I’d refinance at the lower rate now. Then later once LTV is lower they can ask to get the PMI removed.

    Have they shopped around to get quotes from other banks or lenders? Doesn’t sound like it. They should get more quotes on the rate terms.

    Mortgage rates and terms are generally going to be worse on rentals. 1% higher rate on rentals is typical for what I’ve seen and they usually want higher % down. Thats just the nature of the business. People are a lot more likely to default on a rental than their own home.

  6. Big - D says:

    Find a different bank. Many banks offer a range of loans, several with higher rates and get rid of closing costs. I am closing on Friday and I have no out of pocket costs. I did the numbers and it was cheaper for me to take the added 0.125% additional than to pay the $1900 in closing costs on the 15 year loan. It might not be the same if they are in 30 year loan category, but most places offer several plans and are wanting to vie for business of honest people that pay on time for their bills. YMMV

  7. Mike Lutter says:

    Lenders are not your friend and they will never give you advice that hurts them to benefit you. Taking this advice will hurt you in the long run.

    There are none so magical words as saying: “I’ve payed my mortgage regular like a clock for X number of years and was never even late on a payment. I’m a good customer and made a lot of money for you, if you can’t help me now I’m going to go to a different lender. Is that really what you want?”

    Paying on time is what gets you power in this equation, other banks will be tripping over themselves to get someone who always pays on time. Being late, or not paying at all shifts the power to the lenders. Your credit harmed, you are less desirable to other banks and, as such, locked in to your current bank. With that lock-in your current lender knows they can abuse you as much as they want and you can’t go anywhere else. You will pay whatever they want or you will lose your property.

    The smart and ethical thing is to shop around until you find a bank that is willing to give you a better deal.

    • Lazy Man says:

      I’ve tried those magical words and typically the response is, “Go for it. It will cost you more to go somewhere else than it is worth.” I’ve found the subtext is somewhat like “We aren’t going to negotiate on those threatening to leave.” It’s different with cable and cell phone companies for whatever reason.

      I do agree that it’s best to shop around.

      Good comment Mike. Unfortunately your website name makes you my nemesis. Grrrr.

  8. Nicole says:

    Thanks to everyone for your input and comments, however my situation isn’t that cut and dry!! Maybe I failed to explain it the best that I can, but because there are so many scenarios to this one situation, makes it hard.
    Ultimately what is boils down to is the economy and the mortgage financial crisis that the US is in. Banks have made it more difficult for anyone, especially investors to get a mortgage because of the amount of defaults and forclosures. Basically what they believe is that, if the home you are buying isn’t your primary residence, then it would be easier to let that one go if you are having financial difficulties. So therefore, how that applies to me is there isn’t a bank out there that is willing to refinance to the prime rate for a fair price (closing costs) and will most likely only refinance up to 70-75%. I am just barely at 80%, so pretty much refinancing is out of the question. I then proceeded to ask for a rate modification which banks will do to adjust your rate w/o the high closing costs and the bank that my mortgage is currently with now are the ones who refered me to this outside company. They go in on your behalf to get your rate lowered for you, for the remainder of the loan. WHich is 27 years at only 3%. Now seems like a no brainer right?? I thought so as well. However, to miss two mortgage payments(because all it takes to complete this process is 60days) What is that going to do to my credit? Will it take a long time to restore it? Also, what about the credit cards that I have now? Will they be in jepordy?? THose are ultimately my questions. Thanks again in advance for feedback!!

  9. Mike Lutter says:

    My own personal experience with mortgage lenders is that they will not negotiate PERIOD. Threatening to leave or not. I made that comment to appeal to people taking the high road.

    The ‘work-out department’ or the ‘hardship department’ or whatever they call it will not help either. I’m speaking from personal experience here. It’s just a front the banks pretend to run so the regulators don’t come down on them. There are so many little rules and gotchas that almost no one qualifies. Missing payments to get into that pool is about the worst idea ever.

    The big stick is to not just threaten, but to actually refinance with another bank. To do that, please, emphatically, DON’T damage your credit!

    PS Lazy Man: Yeah, I noticed our site names were at odds. :) Don’t worry though, we are kindred spirits: I’ve been pretty lazy my whole life… QuitBeingLazy is my fight to get past it.

  10. Nicole says:

    So, Mike Lutter, what does that mean for me?? What are you saying I should do??

  11. Firstly, mortgage rates are not based on the Prime Rate. Prime affects rates on consumer loans, and HELOCs, and is based on the Fed Funds rate. Fed Funds is an extremely short term (overnight) interbank lending rate. In contrast, a 30 year mortgage rate is based on the movement of the corresponding rate Mortgage Backed Security (MBS), or mortgage bond. As the prices on these fixed-yield bonds increase, the relative yield is reduced, allowing for lower rates with less cost to the borrower. What usually controls the price on mortgage bonds (when the Treasury is not buying to drive rates down) is perceived risk of inflation.

    Currently, virtually all loans are Conventional, meaning the guidelines are set by FNMA and FHLMC (Fannie Mae & Freddie Mac). In most parts of the country, that means 80% max LTV on an investment property purchase, or 75% on a refinance, basically industry-wide. Fannie and Freddie also set increased point costs for non-owner occupied properties, to secure the same rate as a primary residence. But, you can usually take the rate up a bit to cover those points, and potentially some of the standard closing costs. Today, with good credit, you should be looking at mid 5%’s.

    Since you are trying to keep your loan balance down, I recommend bringing about a mortgage payment to closing rather rolling everything into the new loan. Since you skip one following the refinance, that is a wash. Has an appraisal been done? If not, that is of course an unknown variable, and could change the LTV. What are you basing your value estimate on?

    Modifications are an entirely different story. While no one can tell you not to pursue a loan mod, there are some factors to consider. If you have good credit, and have any plans to use it in the next few years, you probably do not want to go late on your mortgage. You are also usually required to furnish your financial information to show your income and assets, similar to your original loan application, as well as an explanation of why you are unable to make your current mortgage payments (your Hardship Letter).

    Lenders are not obligated to modify your Note, since it is a binding contract, but they do want to minimize their losses by preventing impending default. As such, they prioritize based on need. Having had a loss of job, cut in income, or a death of a spouse are all demonstrable reasons for needing a modification, and will be evidenced in your supporting financial docs. Primary residences are generally given priority, as well as ARMs. Some borrowers with ARMs which are currently fully indexed at very low rates (thanks to the very low Fed Funds rate) are actually receiving modification offers without going late or even asking. Lenders are willing to provide an additional fixed period on the rate, slightly higher than the current fully indexed adjustable rate, so they and the borrowers can have some stability. On the contrary, lenders have less incentive to modify fixed rates to lower fixed rates.

    There are attorneys who will offer to assist you with your modification for a fee. Some are reputable. My best advice there is caveat emptor. You are also able to go through the process with your lender directly.

    If you don’t have the value to refinance now, I recommend waiting until you do. Hopefully that will not be too long, with market appreciation and your principal payments.

    Patrick

    I am a loan officer, and have been in the business for 8 years.

  12. Margo says:

    I wholeheartedly recommend against missing payments in an attempt to get a better rate. A friend of mine was referred to a debt consolidation company – she had never been late on any payments and just wanted to lower her rates to make it easier to pay the debt off. She paid it off and NO ONE will loan money to her now. She can’t even get an unsecured credit card, and all her insurance premiums went up. I am literally positive that, if you get into it, this rate reduction program will do the same thing to you. Shop around to other banks or suck it up and keep paying your 7%. Regardless of the moral issue, it’s not a good idea financially.

  13. Teresa says:

    I don’t believe that loan Modification is a solution for all people that have problems to pay their mortgage. Maybe the Loan Modification helped some for a determine amount of time, becouse this is a temporary solution. On the other hand this (solution)is created more problems that helped people. It is a lot confusion and missundertanding between the public and a lot people with low ethics,who took advantaged of their desperation creating a future caos. Better education to the public will be good to protect themselves from predictors. I am not agree with the people that recommended to loss payments, becouse this will have repercutions and a lot of extra charges. Look for a better solution and shopp around until you be sure that you find the best plan for you,this is my recommentation

  14. Brad says:

    Patrick hit the nail on the head. I could not have said it better myself. The only thing I would have said different is that the mortgage note we sign at closing is a contract between the purchaser and the lender. That is all it is. A loan modification is an attempt by the purchaser to modify the contract after the fact, why would any lender sign another contract with someone who modified the last contract. It just does not make sense.
    Good Luck to you.

  15. If you don’t have a hardship, don’t claim to have one. Ask the bank to reduce closing cost and refi if there is enough savings.

  16. Jared Godfrey says:

    Wow, what a world we live in where our ethics are challenged at the cost of saving hundreds of dollars every month. In this case I would say being honest is the best policy. Go the refinance route. You will be better off anyways, rather than a modification. see what you can do to make the refi happen, possibly refi a car for the closing costs or see if the bank will lower its fees or work with you somehow. Modifications, ruin your credit, are not permanent cost reductions, and are not guaranteed and many times cost money up front.

    • Lazy Man says:

      The refinance route isn’t always an option. Most everyone I know who bought in 2004-2006 were responsible and put the 20% down. With the drop of value in the houses, they no longer have 20% equity and can’t be easily refinanced. There’s an option for a responsible person to put another few thousand dollars in to get back to the 20%, but not everyone has that kind of spare cash lying around.

      On the other hand, the irresponsible people who over-extended themselves on bad loans with little money down are given the option of reduced payments at no cost to them.

      Think of the message that sends… just be irresponsible and you’ll get bailed out. Play it straight and it will end up costing you big bucks. I guess it works for banks and auto manufacturers.

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