Helping Low-Income Homeowners Overcome Barriers to Refinancing
With mortgage rates holding steady at or near record lows, refinancing continues to be a powerful tool to lighten the debt burden of most homeowners. Unfortunately, lower-income borrowers often hold back on striking a better deal through refinancing, and lenders may not recognize the extent to which refinancing improves the odds of sustainable homeownership for this customer group.
However, by working with consumers to address their misconceptions regarding refinancing, housing professionals can help eligible low-income borrowers take full advantage of this historic opportunity to lower their monthly mortgage payments and better position themselves financially during the current recession. For example:
- A 1% reduction in interest rate for a $125,000, 30-year mortgage can generate $70 in monthly savings or $840 annually, which can make a meaningful difference for a low-income household.
Uncertainty and Financial Anxiety for Low-Income Homeowners
Low-income homeowners may be unsure if they can refinance their mortgage, or they may believe the rules preclude them from switching out a higher-rate loan with a less-costly one. And some may perceive that lenders aren’t motivated to do business with them as refinance customers.
The bigger the dollar amount of any loan transaction, the more it stands to discourage some borrowers from going through the loan process again, even if it puts them ahead financially in the long run. Pulling together the documents a lender needs for a new mortgage can feel overwhelming, especially if an applicant thinks they have low odds of getting an offer that makes refinancing worthwhile.
Increasing Demand for Refinancing
With the housing market still one of the most resilient sectors in the economy, millions of Americans are refinancing or securing new mortgages to purchase a home. In this business environment, loan officers may encounter additional challenges supporting refinancing for low-income borrowers. For example:
- In such an active origination market, loan officers may feel they lack the time and resources to provide necessary support and education to lower-income consumers curious about refinances.
- Many have difficulty explaining the break-even point on a refinanced loan considering closing costs charged (For example, a $250 decrease in monthly payments recoups $3,000 in addition to the loan balance in a 12-month period).
- Housing counselors are a great resource for loan officers in helping borrowers to better understand their financial options. But many housing counselors today are busy supporting borrowers who need immediate help to avoid becoming delinquent or defaulting on a loan.
How Refinancing Can Help Low-Income Homeowners
Despite the challenges for low-income homeowners and for the loan officers who can support them, the benefits of refinancing are there.
“The total savings stemming from refinancing a loan is not always obvious for a mortgage holder,” said Samuel Luna, senior director of Single-Family Affordable Lending for Freddie Mac. “But seemingly small monthly savings can be significant and worth pursuing when looked at over the life of the loan.”
Refinancing with a new loan under new terms can improve a low-income borrower’s situation by:
- Freeing up money each month that’s no longer required for mortgage payments to offset other living expenses or build savings by extending the amortization at a lower rate back to 30 years..
- Increasing equity more quickly by switching to a shorter-term that’s affordable at a lower rate.
- Switching to a fixed-rate mortgage from an adjustable rate mortgage (ARM) to limit the risk of higher interest costs in the future.
- Paying less private mortgage insurance (PMI) by switching from a Federal Housing Administration (FHA) mortgage to a conventional loan with lower-cost mortgage insurance (MI) that is cancellable.
- Eliminating mortgage insurance outright if the loan-to-value ratio on the home is 80% or less at the time of refinancing.
Financial Realities and Misconceptions about Refinancing for Low-Income Borrowers
There is no such thing as a free loan. Closing costs for a new mortgage average about $5,000, but this shouldn’t be an automatic deal-breaker for borrowers with less cash on hand to pay them. What matters is their personal financial situation and the degree to which savings outweigh expenses. It may make sense even to finance closing costs in the loan amount or through a slightly higher interest rate. Low-income borrowers may also be eligible for grants to cover the closing costs.
However, an important advantage is that for many low-income borrowers, lenders will still be able to refinance their mortgages without having to pay a fee of 50 basis points on the amount of the new loan. The rule, which takes effect on December 1st, exempts borrowers in these circumstances:
- Borrowers with loan balances below $125,000, nearly half of which are held by low-income borrowers whose annual income is 80% or less of the area median income (AMI) where their home is located.
- Home Possible® refinance mortgages, even if the balance is greater than $125,000.
- Borrowers with HFA Advantage® loans if the balance is less than $125,000 or if the borrowers’ annual income is 80% or less of AMI.
Ways to Promote Refinancing to Low-Income Borrowers
Lenders can lower refinancing obstacles for low-income homeowners through divide and conquer. By targeting the needs of each audience with separate initiatives, the task grows simpler and more appealing as a priority.
For in-house teams:
- Informational materials, such as FAQs and worksheets or infographics, to more clearly show the benefits of a new loan with a lower rate or better terms.
- Proactive training for loan officers to work as effectively and efficiently as possible with low-income borrowers.
- Make it easier for loan officers to pass on foreign-language versions of widely available educational materials or online educational programs borrowers have to take to qualify for affordable lending solutions.
- A consumer awareness campaign dispelling the myths discouraging refinancing among this borrower segment and spelling out benefits beyond just lower monthly payments.
- Educational materials on how proceeds from a cash-out refinance can fund home repairs and renovations that can improve the home value, or energy efficiency upgrades that lower utility costs.
- Use multimedia channels, such as podcasts, to educate homeowners about refinancing.
For housing ecosystem partners:
- Leverage relationships with minority or trade associations to increase awareness about the value of refinancing for their members.
- Develop a training curriculum that housing counselors and other trusted advisors can use to walk borrowers through the cost-benefit analysis of refinancing, including the break-even point.
A proactive campaign—supported by industry leaders—stands to help borrowers overcome the misconceptions of refinancing. Less mortgage debt over time can make the difference between holding onto a home or having to sell it for borrowers with less margin for error during hard times. Now is the time to try.