Rates are Low--Where Are All the Refis?

Jean Braucher's post on the Hubbard-Mayer housing market reform proposal points to a really interesting question:  why is it that despite historically low interest rates, there has been relatively little in the way of refinancings?   This is a critical question because the housing market has traditionally been a prime channel through which the Federal Reserve can use interest rates to affect the economy.  I've seen one estimate that the missing refinancings would put $90 billion into the pockets of mortgaged households (around 50 million of 'em) every year, without affecting the federal budget.  That's real a direct-to-consumer annual stimulus of $1800/mortgaged household. So, what's preventing more refinancing activity?  

The Hubbard-Mayer proposal, unfortunately, never really gets into the question of why there aren't more refis.  Instead, it gallops straight to a proposed fix, which, as Jean points out, is tragically naive when it comes to the institutional realities of servicing.  (Chris Mayer and I have had a version of this argument before regarding cramdown.)  

To be sure, some of this discrepancy between low rates and low refi levels can be explained by the large number of borrowers with damaged credit and/or underwater properties.  Part of it (not very much by my reckoning) can also be explained by the mortgage industry shifting personnel from underwriting to loss mitigation.  And banks might be gun-shy with their underwriting because GSE/FHA putbacks are starting to bite.  But I think we might need to look to the question of transaction costs to find our answer.

There's been a dramatic growth in mortgage refi costs since the financial crisis started.  The spread between primary and secondary market pricing is now 100bps higher than that pre-crisis.  That means that the spread between mortgage rates and mortgage bond coupons is now around 1% higher than it had been pre-crisis.  In other words, there's an additional 100bps of transaction costs that have been added.  And that only accounts for loans that are actually closed; to the extent that transaction costs prevent refinancings, the costs are not reflected in the primary-secondary spread.  

What explains the increased transaction costs?  Some of this is from the primary market, which has become more concentrated as many mortgage banks and some major banks have simply disappeared.  Some is from the secondary market:  the GSEs are charging a quarter point on all loans for adverse market conditions and then up to three points on other loans for various credit characteristics (loan level pricing adjustments).   The GSEs' additional charges might make good sense on new originations , but I can't follow the logic of charging points to discourage refis.  The refi at a lower rate only reduces credit risk, so why price adversely to it?  

I think a critical task for the administration is to determine how much of the absence of refis is due to caution from chastened financing institutions, and how much is due to increased market concentration, including the secondary market duopoly in the conventional, conforming market.  If the issue were merely caution on new originations, I'd be inclined toward the former explanation, but when the GSEs are obstructing the refinancing of credit risk that they already hold, I'm less certain.

For all of its problems, I'll give Hubbard and Mayer some kudos.  They're at least trying to be creative.  Would that we would see such a level of initiative from this administration.  

Comments

[Ted K]

Why would a bank (say for example Wells Fargo) refinance when the two other results from NON-refinance are get a higher rate on your loan or.... take possession of a house and real estate??? Because the banks don't want to take entire possession of a house and land because of the property taxes??? I'm sure you'll think I'm being a simpleton, but I don't think it's rocket science. Some of these people are maxing out credit cards, and cashing out their 401k so they can pay their mortgage, because some bastard like Larry Kudlow is on TV telling them they are bums for running out on mortgages, while Kudlow is telling some multi-millionaire on his show what a savvy businessman he is for dumping all his office building leases in the metro areas.

[KJMClark]

I think you've found the problem. I've been watching the rates with an eye toward a refinance. We have no problems with equity, excellent credit, and a 5.25% 30-yr fixed mortgage. I'm waiting for a percentage point lower and no points. Looks like I'll keep waiting, since the rates at my bank are 4.25% with 1.375 points for 30-year fixed.

I've been puzzled by how high the mortgage rates are compared to the 10 and 30 year bond rates. I think you've explained it.

[cindy]

Another problem is the WAIT-PERIOD. Our family has excellent credit, but cannot merge our primary mortgage and home equity
into one larger jumbo (less than $550K) 30-year fixed, because our
home has been listed for sale this year. Once your home has been listed, practically every lender has a waiting period of 4-6 months
after your listing ends to take a refi application from you.

[Ed]

Don't forget that several of these people have second mortgages and so they don't have enough equity to refinance into one larger loan.

It's mostly that almost all properties are underwater that have a note on them.

[Ken Doran]

I suspect that several streams merge into a strong current against refis, many mentioned above, including equity ratios, income issues, multiple mortgages and the various lender-side concerns. I would also suspect that since refis were a prime vehicle for scamming homeowners and destroying equity, there is a justifiably high level of suspicion in the marketplace.

[Dave S.]

What Ed said. I'd love to refi, but we did an 80-15-5 and don't the 15 lying around to put in.

[Hillary]

Among my friends, comps are stopping them from refinancing. One friend and his wife have reasonable equity in a small house in a good neighborhood, but the loan officer told them to not even try refinancing because a foreclosure that's roughly comparable (neighborhood and square footage) sold for 50% of what they paid.

[Lil'D]

So, Hillary, why do you think they actually have "reasonably equity" if sales are occurring at such low prices?

[LittoralKey]

I'm new to your blog, thank you for the efforts, it is very well written.

ON that note I believe another situation as mentioned above by Hillary is merged with a second situation. IN many (most) non-recourse states, a refi will covert the mortgage to full recourse.

In this sense, rational mortgagers are losing the average of $1800/year/mortgage as a sunk cost option. The option to escape the mortgage with non-recourse is worth the avg $1800/year to rational folk.

In an era of inflationary/deflationary uncertainty and perceived inflation/deflation volitality, mortgagees who believe well see either hyperinflation, inflation, stagnation, deflation, or hyper-deflation can all make rational arguments to forgo the $1800/year for future freedom from liens on future income streams.

I've added your blog to my rss feed...

regards,

[Chris Mayer]

Hi Adam and others-

Thanks a lot for your comments. As you can see, I have posted a response on Jean's line, so I won't repeat our conversations there.

You highlight several important issues that are impairing the process. Understand that in an op-ed we do not have unlimited space to go thru details of how we got here and why this is the best solution. But we are happy to take on those issues in this format or elsewhere. I would not say that our proposal is naive, however. It addresses an enormous number of practical complexities. We have a posted description of our proposal and an FAQ (http://www4.gsb.columbia.edu/realestate/research/housingcrisis).

I agree that it is unconscionable that the GSEs as wards of the taxpayers are not doing everything possible to help refinancings. They are trying to mark up the price of refinanced loans because they say that these loans are risky; but they already bear the risk, so turning down the refinancings is bad business, not just bad policy. Under conservatorship, they are supposed to do any program that would increase their profits. I do not see how they can argue that expanded refinancing is not in their business interest. (See more in my blog posting for Jean).

For new housing credit, the US government is the only game in town. The GSEs or FHA are originating more than 19 out of every 20 new mortgages. So any proposal that is going to work in the short-run in providing new credit is likely to come from the US government. The GSEs should be actively taking steps to reduce costs imposed by servicers (their fees have gone from 20 basis points up to 90 basis points). Once again, charging such high fees is unacceptable and needs to be addressed with policy. As well, title companies charge a large amount to refinance a mortgage, when their risks do not change. Again, this can and should be fixed.

We must take aggressive action to help housing and homeowners. This proposal does not take on all the problems (privately securitized mortgages, underwater second liens, and bank mortgages), but it addresses about 2/3 of all outstanding mortgages. We have not seen any better ideas coming out of DC. Now is a good time to take some action to help the economy and middle class Americans, while reducing costs of the GSE bailout for taxpayers.

-Chris Mayer

[Katie Porter]

Just a quick note to thank Chris Mayer for participating in the conversation and sharing more details of his proposal.

[Elder]

Some loan officers I spoke to say that they no longer have the discretion that they had 2 years ago. The criteria for getting a loan has also changed significantly. You need to have much more income/equity to get the same loan.

[Russ]

I am a Loan Officer. Rates are low, but hardly anyone qualifies anymore mainly due to low appraisals and Fannie/Freddie have tightened up their guidelines as well. To be frank, a lot people don't qualify over technicalities as well. We see very few people unqualified due to credit/income but a lot deals get shot down over obscure underwriting requirements, particularly if the property is a condo.

Costs are also going up as well. We can thank the local hero Mrs. Warren and her efforts to kill off mortgage brokers with her non-sensical rant on yield spread premiums among other new regulatory changes are driving up costs.

[Nathanael]

Final thought: suppose you have a mortgage which, by some miracle, is held directly by your local bank.

Why cloud title by refinancing and getting involved in the MERS mess?