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February 5, 2001
"I recently read an article
that said that savvy borrowers could avoid the costs of refinancing by
getting their lender to agree to a modification of the rate on the
existing loan. If the old loan stays on the books, the settlement costs
of a new loan are avoided. He said he got his loan modified for
$35. Why is this not a widespread practice?"
When market
interest rates drop, a lender would rather drop the rate on a fixed-rate
mortgage in good standing than lose it to another lender through a
refinancing. On the other hand, if the borrower isn�t going anywhere,
the lender doesn�t want to drop the rate. The lender�s objective is to
drop the rate only if necessary to prevent loss of the loan.
If the lender is servicing its own
loans, it may allow rate modifications for borrowers who request it. The
writer who had his loan rate modified for $35 was one of them. But this
doesn�t happen very often. The writer belonged to a dwindling group of
borrowers whose loans are owned by lenders who do their own servicing.
Most loans today are serviced by
lenders who don't own them. They sold the loans soon after closing and are
now servicing agents of the owners. Except under special arrangements of
the type described below, the owners do not grant their servicing agents
the right to modify the interest rate.
This reflects a conflict between
the interest of the owners and the interest of the servicing agents.
Owners fear that if agents had the discretion, they would agree to rate
reductions too readily because they lose nothing from a rate reduction.
Servicing agents make their money
from a servicing fee, usually 1/4% of the loan balance. The fee is
deducted from the borrower's payment before the agent remits the remainder
to the owner. A rate reduction that retains the customer protects the
agent�s servicing fee but hurts the owner.
There are ways to reduce this
conflict in
order to make rate modifications possible. One approach is to
charge the borrower a fee for the right to have the rate reduced in the
future, with the fee split between the servicing agent and the owner.
Countrywide Home Loans and Wells Fargo Home Mortgage have programs of this
sort developed in collaboration with the Federal agencies Fannie Mae and
Freddie Mac, who buy the mortgages from them. These programs have not had
much market impact to date.
While lenders will seldom allow
servicing agents to reduce rates, they don't want their loans being
refinanced with other lenders either. Hence, they allow and even encourage
their agents to adopt "loan retention programs". Under these
programs, the agents attempt to identify borrowers who are likely to
refinance, and try to head them off at the pass with their own refinancing
proposal.
Because loan retention programs
create a new mortgage, they generate settlement costs. Some lenders, and
the major Federal agencies Fannie Mae and Freddie Mac, have offered
"streamlined refinance" options. These programs reduce the
required documentation and costs when lenders refinance loans that they
have been servicing, for which they have the borrower�s payment history
right at hand.
A few lenders have combined
streamlined refinance with "no-cost" mortgages to offer programs
where borrowers can refinance at little or no cost whenever interest rates
decline. A widely publicized program of City Line Mortgage allows
borrowers to refinance by paying only for title insurance. All other
settlement costs are borne by City Line.
City Line prompts borrowers when
the market has fallen .5% or more below the rate on their mortgages. The
borrower must request the refinance and must have a good payment record,
but City Line does the work using "streamlined refinance" rules
set forth by their investors.
The appeal of this program to
borrowers is that refinancing is quick and easy, the refinancing cost is
very low, and the lender prompts them when the opportunity is there. The
downside is that borrowers pay an above-market rate when they take out
their loan.
On January 11, 2001 I found that
City Line�s quoted price for new customers on a 30-year fixed-rate
mortgage was about .625% above the rate available from three mortgage
shopping sites. That�s a stiff price to pay for a low-cost refinance
option.
Copyright Jack
Guttentag 2002
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