"Real Estate Loans Upside Down" (CITS DEBT WATCH)

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                    W. Curtiss Priest, Ph.D.
          Center for Information, Technology & Society
              466 Pleasant Street Melrose, MA  02176
  E-mail: BMSLIB@MIT.EDU, Voice: 781-662-4044, FAX: 781-662-6882


                            May 8, 2003

                        Public Issue #:100

                          CITS DEBT WATCH

                 "Real Estate Loans Upside Down"

           Commentary by Dr. W. Curtiss Priest, Director:

I am fairly certain that 99.9% of the Boston Globe readership
read the article below and started thinking about how they,
too, should refinance, and how they, too, should extract the
enormous equity from their homes for everything from "home
improvements" to other purchases.

According to a recent announcement by the Harvard Center
for Remodeling Futures (Boston Globe, 5/2/2003, p. D9)
"homeowners continue to spend record amounts to remodel."

As some kids say, ohmygosh !

Based on that article, over one percent of the entire U.S.
GDP derives from home remodeling.

And where does most of that money come from?  It comes from
"cash outs" on home refinancing.

Let me be very specific.  Say a homeowner owns a home, and
in a "sane" marketplace, that home is worth $150,000.

But, currently we have insane marketplaces for homes, and,
yes, especially in the Boston area.  Little did I know that
the house I bought in Melrose, MA would be my "best"
investment for the decade!"  So while 401(k)'s etc., are
off 20-40%, my house has more than doubled in price (not
value) in the last ten years.

And, yes, part of me says, "sell" and move to Montreal.
However, while my efforts are mobile, my wife teaches at
a local college, thus tying us down.

So, if I "play the game" that my $130,000 house is "really
worth" $300,000 or $400,000, I could suck out equity until
"the cows come home."

I don't.

Now, while home prices are bizarre, there is even something
more bizarre that is described in the article below.

It costs less to ask banks for a second mortgage -- a "home
equity loan" -- than it costs to refinance the original
mortgage!

Again, ohmygosh.

As any sensible lender knows, the "first mortgage" on a
property comes before any second loans.

So, in the past, a "home equity loan" was 1.5 times to
2 times more costly because the bank, fearing a default,
needed to build a "risk premium" into the 2nd loan.

But!  Notice the advice of Ms. Anderson, below.  She
notes that second mortgages are "less" than first!

So, she advises that the homeowner take out a 2nd mortgage,
and use some of the money to pay off the first!

ohmygosh, again!

This is the most bizarre lending practice that I can imagine!

Somehow a 2nd mortgage on a home "costs less" than a 1st
mortgage.  And while some of this may be an artifact having
to do with differences in "closing costs," it is difficult
for this writer to believe that those (tiny) costs have
much to do with what is really happening.

No.  This is shear insanity.

Regards,

WCP

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To refinance or not to refinance

Even incremental declines can pay off, experts say

By Andrew Caffrey, Globe Staff, 5/8/2003

hough he refinanced his Boston condominium for the second time just
last October, at 6.125 percent, Jon Crellin nonetheless readied
himself to "pounce" again if rates broke through his "psychological"
barrier of 6 percent for 30-year loans.

He got his chance a few weeks ago, when mortgage rates began to tiptoe
down again, and locked in a new 30-year fixed-rate loan at 5.75
percent - without paying points or closing costs.

Crellin admits his old rate was pretty good, "but I love to have that
five-and-three-quarter."

After creeping up earlier in the year, mortgage rates are again
flirting with 40-year lows.

In the Boston area, 30-year fixed-rate mortgages averaged 5.78 percent
last week, compared to 6 percent a month ago and 6.5 percent in
October, according to HSH Associates, a mortgage-data provider in
Butler, N.J.

Rates on 15-year fixed loans averaged 5.16 percent, down from 5.85
percent in October.

After a record number of refinancings last year, many homeowners are
wrestling with whether it's worth doing it again so soon after their
last loan, when the monthly savings seem small.

"You really have to ask yourself, `Is it worth going through a lot of
rigamarole for $40 a month?"' said HSH vice president Keith Gumbinger.

With that $40 monthly savings adding up to around $2,400 over five
years and $14,000 over the life of a 30-year loan, Gumbinger said,
"the answer for a lot of people is, absolutely."

The math may soon get even more compelling, thanks in part to the
lousy economic outlook.

On Tuesday, Federal Reserve policy makers said the tepid economy is
more at risk of falling prices, or deflation, than it is of inflation
- which analysts said means the central bank won't be raising interest
rates for months to come.

The combination of a slow economy and steady Fed policy, Gumbinger
said, should serve to keep mortgage rates "on a stable - to a
potentially slightly downward - path."

Moreover, as the pool of applicants naturally declines from such high
levels, lenders are in a bidding war to win business, which will also
nudge rates down. Yesterday, the Mortgage Bankers Association of
America said an index that measures refinancing activity jumped 19.4
percent last week, after having declined for the previous six weeks.

Other borrowers have found it easier to justify refinancing at
incrementally lower rates because of the popularity of no-point,
no-closing-cost loans.

For example, Allison Horne, owner of mortgage broker Dynamic Capital
Mortgage in Brookline, said cost-free 30-year fixed mortgages are
currently priced at 5.75 percent, compared to 5.5 percent for a
similar loan with closing costs that run about $2,200. On a $250,000
loan, it would take almost five years for a borrower to recoup the
closing costs associated with the lower interest rate.

Wanda Luettgen and her husband refinanced their Winchester home three
times in the last year to take nearly $150,000 out of the house to
finance an upcoming renovation. "We could have waited a little longer,
but it seemed the time was right," said Luettgen, a real estate
attorney now at home with three small children. The rate on the
five-year adjustable rate mortgage the couple just closed on is 4.85
percent, down from the original 7.75 percent no-point loan in 1996.

Booming property values allow Luettgen and other borrowers to take
cash and manage higher debt loads. For example, while the balance on
Luettgen's new loan is $409,000, the appraised value on her home is
now up to $652,000 - before such things as a master bath and family
room are added. Luettgen said better homes in her neighborhood now
sell for $800,000 to $900,000. "We're hoping it gets to that point"
with her home, Luettgen said.

Since buying his Boston condo in March 2000, Crellin and his wife have
refinanced three times. They have a primary mortgage and a second
equity loan. Crellin figured that bringing the primary mortgage down
from its original 8 percent rate, along with other steps to lower
their debt, has cut the couple's monthly payments by about $850. The
newest refinancing allowed Crellin to reduce his equity loan, and lock
more of his condo debt into that secure 5.75 percent mortgage.

A hotel manager at the Fairmont Copley Plaza, Crellin debated going
with a lower adjustable-rate mortgage, since he and his wife may buy a
larger home in the suburbs. But if they do, Crellin said, he may keep
the Boston condo as an investment. "In case I end up owning it long
term, I do want to take advantage of the low rates now instead of
kicking ourselves in five years," when adjustable rates could be much
higher.

For homeowners who know they won't be in their current homes in three
to five years or so, adjustable-rate mortgages are more attractive,
since they can be a full percentage point or more below fixed-rate
mortgages.

Meantime, Susan Kaplan, a financial planner in Newton, said clients
with mortgage balances under $100,000 are having trouble getting banks
to refinance those amounts, because they're less profitable. Instead,
she has clients take out adjustable-rate home equity loans that have a
fixed rate in the first five or seven years. The application process
for home-equity loans is much faster, she said, and rates can be one
percentage point or more below mortgage rates. She uses the proceeds
to pay off the client's primary mortgage and then structures the
repayment amount so the home-equity loan is paid off at the end of the
fixed-rate period.

Joan Gray Anderson, professor and codirector of the Center for
Personal Financial Education at the University of Rhode Island,
cautions that homeowners who are at least several years into, say, a
30-year loan, should refinance into a shorter-term loan instead of
resetting the clock at 30 years on a new loan.

While shorter-term loans have higher monthly costs, the longer-term
loans add years of unnecessary interest payments.

"I hate to see people continuously refinancing" at 30-year terms
because "basically what they've done is stretch their entire mortgage
payments out from 30 years to 40 years or more," Anderson said. "If
you're not going to cut back on the term, you're never going to get
the house paid for."

Andrew Caffrey can be reached at caffrey@globe.com.

This story ran on page E1 of the Boston Globe on 5/8/2003. c Copyright
2003 Globe Newspaper Company.


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