Different Ways For A Busted Refinancing Plan

I heard about many things on refinancing to get out of the coming ARM reset, and I talked about saving these reset by re-refinancing myself too. But such a successful refinancing depends heavily on the amount of home equity you built up (or the valuation of your home), and is only for people who did not abuse their home equity. If you are an over-leveraged real estate investor, and you plan to refinance your ways out, I think the doors will probably be shut for you. Here are some of the ways that you cannot refi without coming up with extra cash. The following examples use interest-only loan for illustration purpose. Qualitatively things will the about the same if you refi using the same type of loan. But if you go from 30-year fixed to interest-only, or interest-only to negative ARM, your cashflow situation (just for now) will probably look better.

Example #1 (increase in interest rate, with the same payment or affordability):
You need to come up with $49400 to settle the refinanced loan, plus any loan costs of about 0.5% of the property value.

 

Now Refi Term
House appraised value 700000.00 648000.00
DownPay/Home equity 5.00% 5.00%
35000.00 32400.00
1st Mortgage interest 6.00% 6.50%
Interest Only 80% loan 2800.00 2808.00
home equity rate 8.00% 8.50%
Home equity interest-only
loan 15%
700.00 688.50
Total monthly payment 3500.00 3496.50
Loan balance 665000 615600

Example #2 (No change in interest rate, but with a market down by 5%):
You need to come up with $33250 to settle the refinanced loan, plus any loan costs of about 0.5% of the property value.

 

Now Refi Term
House appraised value 700000.00 665000.00
DownPay/Home equity 5.00% 5.00%
35000.00 33250.00
1st Mortgage interest 6.00% 6.00%
Interest Only 80% loan 2800.00 2660.00
home equity rate 8.00% 8.00%
Home equity interest-only
loan 15%
700.00 665.00
Total monthly payment 3500.00 3325.00
Loan balance 665000 631750

Example #3 (Tightening in loan underwriting standard, and with a market down by 5%):
You need to come up with $68250 to settle the refinanced loan, plus any loan costs of about 0.5% of the property value.

 

Now Refi Term
House appraised value 700000.00 665000.00
DownPay/Home equity 0.00% 5.00%
0.00 33250.00
1st Mortgage interest 6.00% 6.00%
Interest Only 80% loan 2800.00 2660.00
home equity rate 8.00% 8.00%
Home equity interest-only
loan 15%
933.33 886.67
Total monthly payment 3733.33 3546.67
Loan balance 700000 631750

The above scenario assumes that you bought the property at the height. You can adjust the amount of the home equity/loan balance/home valuation in the Excel spreadsheet here. But the story is the same. If the home values go down, lending standard tightens, and/or interest rate increase, you will be looking at putting up extra cash for refi and/or an increase in payment. Certainly, if you bought your home earlier, the situation is different. But the only reason that it is different is because of the home valuation, not because of the rent collected can be much bigger.

If you are a real estate investor that holds multiple investment properties, the power of the leveraging will work both ways. You will need to multiply the amount of cash needed by the number of properties that you have. When housing market goes up, everything is great. When housing market goes flat or down, the leveraged players are the first one to go. Now instead of the cashflow generating machines, it will become a giant negative cashflow sucker. Until the point that you start to default on your very first loan, the refinancing game for the rest of your loans & properties will probably be over for you. The reason is that all the future refinancing terms will be dramatically worse for you after that.

I think the housing “correction” will have years to run. So any real estate investors in the bubble zone better start selling now, or hold onto any cash that you have. The most straightforward way to get out of a leveraged mess is to de-leverage (by selling).

Unfortunately, more likely there will be some appraisers and mortgage brokers going to jail along with real estate investors at the end. You can find tons of actual fraud reported here at the Mortgage Fraud blog. Yeah, people do go to jail for cheating on their loans.

I just received an investment package for shorting against these mortgages bonds from EuroPacific. Minimum investment is $100K, and minimum networth will probably be $1.5 million (I wish I qualify here). From their studies, here are some eye-popping numbers:
Percentage of option ARM and interest-only originated loans in California:
2002: 2%
2003: 18%
2004: 47%, 10.6% of people has 0% or negative equity in their home.
2005: 61%, 29% of people has 0% or negative equity in their home.
2006: ?

MillionaireMan
 

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