Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Feb 13, 2012

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Today’s home loan borrowers are the brave vanguard of this financial crisis, receiving blow after blow, as they weather declines in home equity, watch the foreclosure numbers rise, and look on in disgust as criminal bank activity continues to be uncovered. As a result of those three factors—and assuredly many others—the home mortgage loan interest rate has broken the floor eight times in the past year, causing the media to go into a frenzy over each one of these newsworthy announcements. Historic low interest rates seems like they would cause a sharp boost in these financially difficult times, but were still seeing the nation recovering at a snail’s pace. People aren’t taking advantage of the home loan refinances available, which begs the question: why?

 

There are a few reasons as to why mortgage refinances aren’t being sought—many of which rest someplace beyond our control. The three main factors include the loss of home equity, tighter lending standards, and unemployment.

 

The Home Equity Massacre

 

What most think when they hear that poor home equity is preventing refinances is: But a refinance will help one regain or retain home equity. Unfortunately, it’s not that easy, as home equity plays a larger part in one’s willingness to refinance than analysts may immediately think.

 

Home equity is the difference between a property’s appraised value and the balance remaining on the property owner’s home loan. If that value is more than the mortgage’s amount, that home owner is said to have positive equity. But, as is all too common today, if a loan’s balance is greater than its home’s value, the owner is said to have negative equity.

 

The problem is if a homeowner has negative equity, a lender will be very apprehensive to grant a home refinance loan. So the “help” in improving one’s equity from a refinance vanishes from sight for a lot of underwater homeowners.

 

And in the event a homeowner has positive equity, they need to have a lot of it in order to make the refinance of any worth. According to CNN Fortune, nearly half of all mortgage loan holders have less than 20 percent of positive equity in their home today. Home equity of 20 percent is a key threshold when it comes to refinancing because of private mortgage insurance (PMI).

 

PMI is required by most lenders on all home loans that don’t have at least 20 percent down. When refinancing, that down payment comes in the form of home equity. If a borrower has less than 20 percent, they can expect to pay PMI.

 

The cost for PMI is usually around 1 percent of the entire loan amount—every year. On a $300,000 home, for instance, one can expect to shell out $3,000 annually for PMI.

 

Now imagine a borrower who put 20 percent down on their initial home loan, then underwent the economic catastrophe we all refer to now as the Great Recession. Let’s say this homeowner is one of the lucky ones who actually has positive equity, but it’s only of 5 percent. While this owner didn’t need to pay PMI before, if he refinances, he can expect to begin paying 1 percent of the entire loan’s balance every year.

 

The savings achieved from a refinance will likely not be enough to cover the PMI—or it may be so close that the hassle wouldn’t be worth it.

 

Lending Standards and Appraisers

 

As mentioned before, most with negative equity are being turned away from any sort of refinance due to tight lending standards. However there’s another, more covert, way that tighter lending standards are affecting one’s home equity. That area is the one of home appraisals.

 

Because lenders are so apprehensive to issue home loans on assets that will lose value or simply be given back to them in a foreclosure a few months down the road, they require their hired home appraisers to be more conservative in their value predictions. As a result, many current owners feel their home values—which subsequently affect their home equity—are being falsely calculated and steered lower than they truly are.

 

Regardless of the accuracy, the number that’s accepted by the lender is what ultimately matters. If appraisers are being more conservative in their estimates, then the homeowner will suffer. With more conservative estimates, home equity declines, leaving the homeowner less willing or less able to refinance.

 

The Unemployment Problem

 

In the event the home equity is present, even after the tight appraisal, a home owner must show proof of income—and that proof must be recent.

 

But as the nation suffers from huge amounts of unemployment and underemployment, proving adequate income is hard to do. Even if one has a low-paying job that allows a homeowner to make the monthly mortgage loan bill, lenders will require an income that they deem is sustainable.

 

Sustainable income in a lender’s eyes allows for no more than 36 percent (sometimes this number is pushed down to 33 percent) of one’s monthly wages to go towards a home loan payment, after bills are taken out.

 

That means if a couple is expected to pay $2,000 monthly, they must make a combined $5,550 a month—and not pay one dime towards other expenditures—if they want a lender to even consider them for a home refinance loan.

 

It’s not difficult to see how the loss of a job, or how being forced to take a low paying job can affect how likely a refinance is.

 

The Carrot on a Stick

 

Despite the fact that we are now continuously seeing historic low interest rates on a regular basis, a refinance boom isn’t occurring because, simply put, it can’t.

 

At least it can’t for now.

 

Until some of the negative remnants left by the housing collapse are remedied, those growing weak from the weight of their underwater home will have to sit patiently and hope this storm soon passes. But when help is dangling right in front of their faces—like a starving man’s carrot on a stick—waiting can be difficult. For encouragement, look at the statistics of the economy growing stronger, unemployment growing weaker, and real estate growing more liquid. If time is of the essence, though, borrowers can try calling their lenders and seeing what it will take to get a refinance.

 

If one’s personal lender is unwilling though, try using the forms found on this site to apply for and hopefully obtain a home refinance loan.