The explosive rise in housing values over the last few years has applied across the board, to homes in every economic sector. The rapid appearance of home equity as home value rose has been too much temptation for a substantial number of people who got into the housing market with a subsidized loan. Both public agencies such as HUD and private organizations such as Habitat for Humanity have made loans available to first time homebuyers with artificially low interest rates – in the case of Habitat for Humanity, down to zero percent.
These programs, along with modest down payments or none at all have made it possible for people of low and moderate income to purchase homes. Many of them have taken advantage of the run-up in housing values to refinance their low cost loans in order to pay off credit cards or other high-interest items such as auto loans. The net result has been a reduction in debt responsibility, and a mortgage at commercial rates that puts a severe strain on the household budget. If one income is lost in the household, the refinanced mortgage payment becomes untenable.
On paper, it’s a financial maneuver that can make sense. The refinanced mortgage will make new cash available because the mortgage is on a home that has gained in value. That cash, coming out of a mortgage with an interest rate of, say, 9% can be used to pay off credit card debt that may include as much as 20% in annual interest costs. It’s a tempting opportunity, despite the fact that many of these refinance loans available in the moderate income market carry high fees and points. Some of the mortgage companies engaging in these refinancing deals for low cost mortgages have the appearance of sharks: adjustable interest rates can start as high as 11% and conceivably reach the 18% mark.
Now, the mortgage not only is carrying interest at a commercial level, it is also paying down a much higher debt that the original, low cost mortgage. The resulting monthly debt can push a moderate household budget to the limit, and any loss of income within the household can result in eventual loan default.
People who have qualified for low cost loans are in moderate income families to begin with, and if they have run up substantial short term credit debt they become questionable risks for new borrowing. For that reason, they are often not eligible for second mortgages or home equity loans that would allow them to pay down their high interest debt and still hang on to the low cost primary mortgage.
There has been enough of this activity that the Federal Reserve Board is considering rules banning the refinancing of low cost loans for a period of time – the suggested period currently in play is five years. Naturally, the refinance specialists are opposed to it. They say that denying people the right to make decisions on what to do with the equity in their home. The professionals involved in putting people into sub prime loans and first-time homes see the current situation as one in which too often, people are signing up for expensive refinance mortgages that they do not fully understand.
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