Refinance Free Credit

This post is from the Blown Mortgage Hall of Fame.  It originally appeared back in July 2007 on my series on credit.  Now more than ever your credit score is vital to securing financing.  I’m on vacation from Saturday until Tuesday the 15th so enjoy some of the classics while I’m gone. 

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Credit is king. In the mortgage industry credit makes or breaks loans. In this five-part series we’ll look at credit from a variety of angles:

1. Why credit is so important
2. Understanding elements of credit
3. Improving your score organically
4. Improving your score using 3rd party help
5. Managing your score

In a lax credit environment - like the one we’re quickly coming out of - your credit score is relatively unimportant; there is ample money and credit guidelines are lax. You can get money from almost anywhere. In 2005 whether you had a 500 FICO score or a 720 FICO score you were looking a low-to-mid 5% interest rates on a 30-year fixed mortgage. And only the lowest credit graded borrowers were being denied 100% financing. Credit was rarely an obstacle and money was exceptionally cheap.

In a tightening credit market your score becomes precious. Today you can’t get 100% financing unless you have over a 720 FICO score (or qualify for some niche-type purchase products); and even then, the rates on the second mortgage are not pretty. It has become cost-prohibitive to have high-loan to value (LTV) mortgages, even with excellent credit. Subprime borrowers face exceptionally high interest rates and borrowing cut-offs at 90% for refinance transactions. Poor credit borrowers are being squeezed by tightening credit and falling home prices. Prime borrowers in high LTV scenarios are feeling the crunch as well.

If you are a subprime borrower and in the middle of an Adjustable Rate Mortgage (ARM) with a prepayment penalty and are worried about your loan there is one thing you must be doing: improving your credit. Improving your credit is the key to avoiding the ARM Reset Foreclosure Trap.

Why Credit is So Important

1. Get Approved - As automated underwriting (AU) became more popular your credit score was made the driving factor of your interest rate and loan approval.  While it was always a factor in the past - automated systems needed something they could easily incorporate in to simple logic and the FICO score fit that bill.  And with that its importance went through the roof.
2. More Options with Less Equity - As your credit score increases you become eligible for higher loan to value (LTV) loan products.  This is extremely important in a falling property value environment because it allows you to refinance out of adjusting rate mortgage (ARM) loans even with little equity left in your property.  With out a high FICO score it is extremely difficult to refinance out of your ARM loan and in to a new fixed rate product.  The resultant ARM reset can put substantial payment stress on you and your family.
3. Access to Cheaper Money - Late payments on your mortgage can disqualify you from the most consumer-friendly mortgage programs.  Avoiding late payments on your mortgage means a substantially higher credit score and the ability to refuse mortgage products that include prepayment penalties and higher interest rates.  Good credit means cheaper money and more flexible loan terms, in all market conditions.
4. Access to More Programs - Good credit not only makes money cheaper; it also provides you access to credit that isn’t available to all borrowers.  If you are a subprime borrower you can’t get a stand-alone second mortgage these days.  The only option you have is to refinance your complete mortgage.  However, if you have good credit 2nd mortgages are available at competitive interest rates.

Understanding Credit and the ARM Reset Foreclosure Trap

The ARM Reset Foreclosure Trap is one of the biggest culprits for foreclosures in the country today.  Here is how it works:

• Subprime borrower takes out a high-LTV ARM loan (cash out of other) under loose credit guidelines
• Property values decrease reducing equity in the property
• Interest rates rise
• Credit guidelines tighten eliminating high-LTV mortgage products for subprime borrowers
• Subprime ARM loans reset to much higher interest rates and monthly payments
• Borrowers are locked out of high-LTV mortgage products due to poor credit
• Borrowers are faced with payment shock
• Borrower have no option but short sale or foreclosure

The only way to avoid this trap is to short-circuit it by improving your credit score.  It gives you the ability to maneuver at the high loan-to-value limits; your only chance to secure a new loan with out experiencing the pain of super-high payments on your now-adjusting adjustable rate mortgage. Credit is the only thing that can save you if you plan on keeping the home.  It is imperative that if you are in the situation above that you spend however much time you have between now and your rate adjustment date improving your credit score - and don’t stop until you’ve gotten above 720.

If you are in a prepayment penalty period it’s OK.  Work on your credit.  If you have 6 months until your rate resets - start now; same advice applies if you have 2 years!  By improving your credit score you improve your prospects of being able to secure financing at high loan to value ratios.  And that is the key to stemming payment shock and avoiding foreclosure, short sale or other not-so-fun remedies.

Now, some people may be in a negative-equity position.  At that point improving your credit will not help you find new financing.  Please see my post on avoiding foreclosure for recommendations to manage that scenario.

In the next part of the series we will focus on the elements that make up a credit score and how you can use the information to improve your personal credit score.  Please stay-tuned to this important series for the rest of the week - it has the potential to save your home; and with banks sitting on short sales it may be the only way you have out of the ARM Reset Foreclosure Trap.

The chairman of the Senate Banking Committee, reacting to criticism that a bipartisan housing bill would do little for homeowners facing foreclosure, vowed yesterday to move quickly on broader legislation to help troubled borrowers get cheaper mortgages backed by public funds. Sen. Christopher J. Dodd (D-Conn.) said he will hold hearings next week on the measure, which is aimed at assisting distressed borrowers, particularly those who owe banks more than their homes are worth because of plummeting prices - an issue at the heart of the nation's housing crisis. Under the proposal, the Federal Housing Administration would encourage lenders to forgive a portion of the loans and issue new, more affordable mortgages in exchange for the federal government's financial backing. In the House, Financial Services Committee Chairman Barney Frank (D-Mass.) will hold hearings next week on a similar measure. He and Dodd said they hope to bring the matter to a vote in their respective chambers by the end of May. In a conference call with reporters, Dodd said he "tried desperately" this week to persuade Senate Republicans to support the FHA proposal as part of a bipartisan agreement to address the mortgage meltdown . But Republicans declined to include the complex measure in the hastily drafted housing bill being debated in the Senate. That measure would provide tax breaks for homeowners and home buyers, more money for foreclosure counseling, and $4 billion in grants so cities can buy foreclosed properties. But most of the money in the bill - $25.5 billion through 2010 - would be the in form of tax rebates to the slumping home-building industry and other businesses that are losing money, a fact that has drawn fire from some economists and consumer groups. Yesterday, Dodd acknowledged that he had reservations about the business-tax breaks. "I would have been more moderate on that, to put it mildly," he said. But he defended the overall housing bill, saying it contains some "very good provisions" and has broken the political impasse that had prevented lawmakers from addressing the problems driving the nation toward recession. "Let me remind you, this is the first time we've gotten anything done. So it's a little frustrating when I hear people say you didn't get as much as you'd like," Dodd said. "Would I have liked more in this bill? You bet. But a month ago, we couldn't even debate a bill." Yesterday, the Senate voted to expand the bipartisan housing bill, agreeing to add tax breaks for struggling Rust Belt manufacturers and for Gulf Coast residents who have received grants to rebuild homes destroyed by Hurricane Katrina. A long line of senators has formed to offer other provisions, including a temporary tax break for first-time home buyers, a plan to let people who are late with mortgage payments take money penalty-free from their retirement accounts, and a proposal to overhaul the oversight of Fannie Mae and Freddie Mac, government-chartered companies that buy up mortgages. Senate leaders expect to wrap up work on that bill early next week. Then it would move to the House, where its fate is far from certain. Frank said the House is likely to concur with the portion of the housing bill that would streamline the FHA, one of the top priorities of the Bush administration. That proposal would increase the size of the loans the FHA can insure, to $550,000 in the nation's most expensive housing markets. The economic stimulus bill recently signed by the president temporarily raised the limit to $729,750 from $362,790. The FHA provision in the housing bill is separate from the proposal by Dodd and Frank to permit the FHA to underwrite risky mortgages. The House is also likely to approve of the Senate's plan to authorize an additional $10 billion in tax-exempt mortgage revenue bonds, Frank said. That provision of the housing bill would permit state and local housing-finance agencies to help an additional 80,000 borrowers, including, for the first time, homeowners trying to shed expensive subprime loans. But Frank said there is "a lot of opposition in the House to the other tax cuts."

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