While it’s impossible to offer a comprehensive explanation for this divergence, most analysts attribute it to the fact that the different mortgages are being utilized by different types of borrowers. “The main users of 15-year loans…are established homeowners refinancing mortgages — people secure enough that they often take on larger monthly payments in order to pay off their loans before they retire…People who take out 30-year loans, by contrast, are generally less well established, with smaller down payments, and require a bigger slice of their incomes to make their payments.” Given the current economic climate, then, it makes sense that lenders are willing to offer a discount to those with an established credit history (i.e. 15-year borrowers), compared to those entering the market for the first time (i.e. 30-year borrowers).

As for those of you trying to decide which duration is most appropriate for you, well, that’s not an easy question to answer. In a nutshell, a 15-year mortgage will save you a tremendous amount of interest (more than half) over the life of the mortgage, but this is offset by a much higher monthly payment. There is also a psychological benefit of being able to pay off the mortgage sooner and not have to worry about spending the rest of one’s life making payments. Summarizes a Freddie Mac rep: “The thinking is that many baby boom mortgagors are taking advantage of the low rates to refi into a mortgage that will enable them to live a relatively care-free retirement life — i.e. free and clear of mortgage debt.”

But with any dilemma, the reality is much more nuanced. For one thing, the monthly payment associated with a 15-year mortgage is significantly higher. Accordingly, one might opt for a 30-year mortgage and simply repay it in accordance with a 15-year amortization schedule. In this way, one retains the flexibility to make the lower (30-year) payment if financial hardship strikes. This “insurance” is inexpensive relative to the overall mortgage, adding $50 a month for a $200,000 mortgage. Skeptics counter that few borrowers are disciplined enough to make the 15-year payment voluntarily and that for those facing financial hardship, making a 30-year mortgage payment will probably be just as problematic as a 15-year payment.

Other proponents of 30-year mortgages point to the extra interest as an advantage, since it is tax-deductible. One clever analyst thought he had figured out a way to save money overall with a 30-year mortgage by exploiting this loophole, but it turns out that the spread between 15-year and 30-year rates has widened to such an extent that “the math no longer works.” Once again, the skeptics rightfully point out that even if you can deduct 30% (assuming a relatively high tax bracket) of your mortgage interest, that still leaves 70% that you are paying to the lender.

Finally, there is also the possibility that interest rates will skyrocket, creating a possible arbitrage opportunity with a 30-year mortgage that wouldn’t exist with a 15-year mortgage. Basically, if you invest the funds that would otherwise have been paid to the lender in a high-yield savings account, you would end up with more money than you would otherwise have had if you simply opted for the 15-year mortgage. But these opportunities are pretty rare, and anyone who argues to the contrary is probably trying to cover up the risk associated with such a strategy.

In short, it’s reasonable to assume that a 15-year mortgage will save you money, compared to a 30-year mortgage. However, the higher monthly payment is an important consideration, and should not be accepted by those with uncertain financial situations. If, on the other hand, your income stream is relatively stable, and you’re eager to escape from under the burden of debt as quickly as possible, the 15-year mortgage is a reasonable choice.

In terms of proof of assets, you should begin by compiling information on all of your bank accounts, including account numbers, the branch address(es), and copies of recent statements. Remember to include information for both checking and savings accounts. You should also plan on furnishing statements of other liquid assets, such as IRA retirement accounts, CD’s, annuities, and estimated cash value of life insurance policies. It wouldn’t hurt to provide valuations for Illiquid assets (real estate, valuables).

The next step is to document your income. This is best achieved through the provision of pay stubs, W-2 withholding forms, and even recent tax returns. If you are self-employed, you should prepare audited income statements for your business. Generally, lenders won’t require more than two years worth of data, but in some cases, they may request additional information.

Even if your creditworthiness has been established (and especially if it isn’t), it wouldn’t hurt to show timely payment of rent and utilities for the last 1-2 years. Your lender will also need to see and legal documents/filings (related to divorce, etc.) in order to determine if any potential liabilities exist.

Prior to the bursting of the housing bubble, it was possible to obtain a competitively-priced loan without providing any or all of the documentation listed above. Reacting to lending standards that were perhaps overly stringent, lenders gradually loosened their requirements. This led to lender complacency and the consequent proliferation of so-called liar-loans, which describe mortgages that require little or no documentation.

In some cases, it is still possible to obtain such loans. Some lenders will accept stated income and/or assets (as opposed to verified income and assets), but you can expect the spread to full documentation loans to be higher than before. According to a recent report, “Less-documented borrowers who reported high incomes were far likelier to default than those whose high incomes were verified – suggestion that loans were made on misleading information.” The report found that applicants were likely to overstate income by 20% on average when verification wasn’t required.

For some applicants, namely those who are self-employed or in-between jobs, a low-documentation loan might still be the best choice. No-ratio loans, whereby income and assets are verified but not used to calculate typical do-not-exceed ratios, might be necessary for those who want to purchase houses that are technically unaffordable.

Of course, you should speak to a loan officer before deciding whether a low-documentation loan is appropriate for you, but it helps to know your options before going in.

From the government’s standpoint, this stipulation was eminently reasonable, since the more underwater one’s mortgage is, the less he has invested in the home and hence the less likely he is to repay. From the standpoint of borrowers – especially those with every intention to repay their mortgages- this requirement made little sense, as it discriminated against them for something they ultimately had no control over.

The government, however, quickly realized how restrictive this clause was: “With home values continuing to drop and the number of delinquent mortgages and foreclosures continuing to rise, it became clear that the 105 percent loan-to-value refinance ratio wasn’t helping enough homeowners lower their monthly mortgage payments.” In its most recent iteration, therefore, this restriction was “corrected,” such that borrowers can now qualify for the refinancing program with a Loan-to-Value ratio of up to 125%. [This is pretty incredible when you consider that a conforming mortgage cannot exceed 80% LTV].

Still, this won’t qualify everyone, especially those in some of the hardest hit areas. According to one economist, “the refinancing program will help those who bought or refinanced their homes in 2003 and 2004 and some who got mortgages in 2004. But he said it still does no good for many who financed houses in 2006 and 2007, when he said prices had ‘gone through the roof.’ ”

Under the new guidelines, borrowers will also be encouraged to shorten the term of the mortgage: “There will be an incentive of 0.125 percentage points on interest rates for opting for a 25- or 20-year term rather than 30 years.” In this way, borrowers that are currently underwater can hopefully move above water more quickly. This will also compensate potential participants for the recent rise in rates, by enabling them to still save on overall interest paid.

Unfortunately for borrowers, the program remains voluntary for banks. While technically you don’t need to be behind (delinquent) on your mortgage to qualify, it seems unlikely that the bank will voluntarily give you a break. In the end, the bank will still decide on a case-by-case basis whether a refinancing or foreclosure is most profitable (or less costly).

The first red-flag is time. From a mortgage duration standpoint, it probably doesn’t make sense to refinance if you are close to (or already passed the halfway point) of your mortgage. For example, if you are 15 years into a 30 year mortgage and refinance into a new 30 year mortgage, you will incur significant additional interest, by effectively lengthening your amortization period by another 15 years. For a modest $200,000 mortgage, this translates into a whopping $60,000 of additional interest payments.

In this case, a better option would be to refinance into a new 15-year mortgage, the net result of which would be no change in the amortization period. If you’re considering such an option, it makes sense to first speak to your lender, who might be willing to modify your interest rate without compelling you to take out a new (i.e. refinanced) mortgage. If a loan modification isn’t an option, the next consideration is how many years you plan to live in your current house. Most experts use two-years as a benchmark; in other words, if you are planning on moving out within the next two years, it will be difficult for you to recoup the closing costs associated with the refinancing.

Red-flag number 3 is your age. If you are nearing retirement age, it probably doesn’t make sense for you to refinance, because then you ensure that you will be making mortgage payments from your savings/pension well into retirement. Who wants to be saddled with such a burden? The only exception is if you have already refinanced in the past and/or have very little equity in your home.

Instead, you might want to consider a reverse mortgage (see yesterday’s post), which allows you to pay off your current mortgage and essentially freeze the equity in your home at a given level (usually no less than 35% of the value of your home) and cash out the difference. As long as you don’t plan to move out/sell your home in the short-term (in which case you “forfeit” some of the proceeds), a reverse mortgage will allow you to remain in your current home indefinitely without having to worry about making mortgage payments (that you would otherwise still be making after refinancing your mortgage).

The final red flag is that you are refinancing for the purpose of debt consolidation/consumption, rather than to save on your monthly payments as a result of a lower interest rate. In recent years, cash-out refinancings have become very common, but I implore you to resist the urge, unless absolutely necessary. It can certainly be tempting to roll all of your credit card debt, auto loans, etc. into your mortgage, which almost certainly has a lower rate. But think of the implications of this: in doing so, you are essentially amortizing the dress you just bought or your car (both of which have limited time use) over 30 years! Besides, if the value of your home goes down, you are now personally on the hook for the difference.

As to whether it makes financial sense to repay- this involves a much more complicated calculation. The general idea is that if you can afford to prepay your mortgage, you should make sure that the money you save (by effectively shortening the term of your mortgage) exceeds the return you would have achieved by investing those hypothetical repayments. Thus, you should begin by comparing the rate that you pay on your mortgage to the rate of return that you think that you can reasonably achieve as an investor.

This basic calculation, however, ignores the tax-deductibility of mortgage interest, which must be accounted for in your mortgage rate. In other words, while your mortgage rate is technically 6%, it might fall to 4% on a tax-adjusted basis, after accounting for the 33% you don’t pay, via your marginal tax rate. At the same time, you need to consider that your investment profits will be taxed by the IRS, at a rate that depends on the type of investment. If you put your money in a savings account, it might be taxed as normal income, whereas if you invest in stocks, you will be taxed at the long-term capital gains rate, and will in effect come out ahead in the tax arbitrage game.

Moreover, you should be aware that there is a connection between the risk and return of what you invest in. While a mortgage rate may not fluctuate much over the life of the mortgage (of course it won’t fluctuate at all if it is a fixed-rate), your rate of return might vary from year to year. Interest rate cuts and stock market declines will certainly erode your ability to achieve your projected return.

Ultimately, if you have the cash to spare, it’s probably advisable to repay. Situations where you are reasonably sure that you can achieve a much higher return than your mortgage rate are probably going to be rare. If you were lucky enough to lock in a 6% fixed rate mortgage while your savings account is currently paying interest at 15%, well that’s a different story. While everyone certainly has a different risk-reward matrix, it’s probably still better to build up additional equity in your house rather than gambling in the stock market.

Before prepaying, make sure that there isn’t a prepayment penalty attached to your mortgage. Fortunately, such penalties have become increasingly rare, and if you do have a penalty, chances are it will no longer apply after two or three years. One final piece of advice- make the repayments directly to your lender, rather than through a third-party, which will charge a fee for managing a process that simply doesn’t need to be managed.

One the one hand, those that failed to lock in low rates for the purpose of buying a home or refinancing are probably kicking themselves. A 50 basis point difference in interest rates translates into tens of thousands of Dollars in added interest payments over the life of the mortgage. As a result, “mortgage applications…fell 16 percent last week, the Mortgage Bankers Association reported. Refinancing applications, which account for more than 60 percent of the total, fell 24 percent.”

Experts caution, however, that everything is relative. Rather than focus on the fact that rates are higher than last month, why not focus instead on the fact that rates are still around 5%, and near a 50-year low. For those looking to refinance, it might still be worthwhile, as long as you plan to stay in your home for at least a few years and your current mortgage rate is above 6%. Homebuyers (i.e. those thinking about an original mortgage), meanwhile, still have an opportunity to get a good deal, especially if home prices fall further in order to “equalize” the higher mortgage rates.

What’s the short-term prognosis for mortgages rates? To answer this question, it’s important to first understand the mechanics of the mortgage system. For those of you who aren’t familiar, consider that while rates are technically determined by your respective lender on a case-by-case basis, such lenders are ultimately guided by macro forces, specifically by investor demand for bundled mortgage securities. Demand for such securities (known as CMOs in industry parlance) had been artificially inflated (to the tune of $500 Billion) by the Federal Reserve Bank. This alone was largely responsible for the spring mortgage rate nadir.

However, the Fed may suspend its CMO program for fear of overstimulating the economy and stoking the fires of inflation. In other words, “Only if the Fed announces their intentions of buying lots more mortgage-backed securities and Treasury bonds, and lots of them,” will rates return to previous levels. Still, there is “a slight chance that rates could return to the mid-4 percent range, and I certainly hope they do. But most experts feel that the party is over and that we may be facing inflation in the near future.” In short, it’s near impossible to predict; my only advice is to not get caught trying to time the market…

Most of you have probably never heard of a wraparound mortgage, and for good reason. They are incredibly risky and not very common. But before I get ahead of myself, let me first back up and explain what exactly is meant by the term. Simply, a wraparound mortgage is used to describe a scenario in which a home-seller offers a mortgage directly to the home-buyer, the monthly payments from which are used to pay down an existing first mortgage.

If you’re scratching your head, consider a more concrete example. Let’s pretend that you have an outstanding mortgage on the house you just sold. With a wraparound mortgage, you would collect mortgage payments from the home-buyer, which would be used to pay down your initial mortgage, and you would earn the spread between the rate that you pay and the necessarily higher rate that you collect.

How would you ever find yourself involved in such a byzantine scenario? It’s possible that given the current desperate housing market, a buyer would be forced to offer a special arrangement to a (un-creditworthy) seller in order to close the deal. This is pretty unlikely (and not recommended) as wraparound mortgages only make sense when interest rates are rising rapidly, in which case the interest rate on the original owner’s mortgage could be significantly lower than a rate that even the most creditworthy homebuyer could hope to secure. In such a situation, a wraparound mortgage would be beneficial for both parties. In the current interest rate environment, it’s not likely that this kind of deal would ever be worthwhile for the seller, who must ensure the timeliness of mortgage payments and could even find himself having to foreclose on the property if the buyer became “delinquent.” That’s what banks are for…

Shifting gears slightly, let’s look at the surge in popularity in 15-year fixed rate mortgages. 15-year rates have fallen even faster than 30-year rates; even adjusting for the recent uptick, they are still close to a record low. [Chart courtesy of NY Times].

You may recall from an earlier post (”Refinancing: Fees/Taxes Versus Interest Rate Savings“) or from other articles you have read about refinancing, that it can sometimes be difficult to make the math work. One nearly surefire way to guarantee savings is if you refinance into a 15-year mortgage.

The problem is that these savings are condensed into a shorter time period, which means while you’re overall savings are often tremendous, your monthly payments may actually increase. Accordingly, some experts recommend that you simply refinance into another 30-year mortgage, and use any extra cash (that you would have otherwise would have spent on higher 15-year monthly payments) and use it to pay down your mortgage early.

Finally, consider that the consolidation in financial services as a result of the credit crunch means that three banks (JPMorgan Chase, Wells Fargo and Bank of America) now dominate the mortgage market. “After buying out a raft of distressed rivals, the big three now account for the lion’s share of U.S. mortgage originations. They also service about half of U.S. home loans, mailing out and collecting mortgage payments even for loans they did not originate.” For this reason, it’s important to do your homework when shopping for a mortgage to make sure that less competition doesn’t inherently translate into a worse mortgage!

If you fall into this category, don’t despair! It’s still possible for you to make refinancing financially worthwhile. The goal is to offset the higher interest rate by finding other ways to save money. Of course, it requires you to be creative- not to cut corners, just to take advantage of opportunities to achieve piecemeal savings.

Let’s start with closing costs. First of all, you should ask for the “reissue rate” when renewing title insurance, which is fair since a transfer of title is not necessary. As long as you’re not pulling money out during the refinancing, you should also be able to skimp on the appraisal. Rather than forking over a thousand dollars for a dubious official appraisal, why not settle for a simple one? You might also be able to forgo a credit check, since the lender should be “intimately familiar with your payment record.”

Speaking of the lender, you might be able to save money by refinancing with your existing lender rather than seeking out a new one. Also, you might want to roll your closing costs into the loan to avoid making an upfront payment. However, be advised that this is typically cost-effective only if you plan to remain in your home for only a few more years, in which case the closing costs can be repaid in full together with the mortgage.

Finally, there are a couple of tax benefits that you may not be aware of. First, you can deduct the points you pay on the mortgage. In the case of a refinancing, “instead of writing off those points all at once, you must spread the deduction over the life of the loan…If you refinance that mortgage again, though, you can generally deduct the remaining points in the year that your loan is paid off with the second refinancing.” In addition, you might be eligible to deduct the private mortgage insurance premium, applicable to mortgages involving a down payment of less than 20%. If you refinanced after 2007 and itemize your deductions, there is a good chance you qualify.

Even if you can’t achieve any of these additional savings, you shouldn’t rule out a refinancing. Generally speaking, it probably makes sense to refinance if closing costs can be fully “recouped” after a couple of years of lower monthly payments, although naturally this calculation can become more complicated if you alter the terms/structure of the loan.

For more information, please review the May 15 post, entitled Refinancing: Fees/Taxes Versus Interest Rate Savings, and make use of the Mortgage Refinance Calculator.

In the month of April alone, 127,000 mortgages were modified. If you include repayment plans (categorized separately from loan modifications for statistical reasons), the number rises to 270,000. Bank of America alone – via its now-defunct Countryside Financial unit – has already logged 50,000 modifications, with another 350,000 remaining- if it fully honors the terms of a legal settlement, that is.

Loan modifications work as follows:

“To qualify, mortgage holders must be an owner-occupant of a one- to four-unit property. The loan must have been originated on or before Jan. 1 and has an unpaid principle balance of no more than $729,750 for one unit properties –higher limits apply to multiple units. The mortgage payment must exceed 31 percent of gross monthly income, and the payment is not affordable because of a change in income or expenses.”

Once the terms are met, “Borrowers must make three months of timely payments before they qualify for federal aid, which will keep their interest rate as low as 2 percent for five years.” Participants are naturally advised both to be on the lookout for scams and to be aware that loan modification is not a given, and that in most cases lenders will only reluctantly agree to do so.

The unfortunate contradiction in this program is that for most homeowners, a loan modification does not get to the heart of the problem; home values have fallen so much and economic conditions remain so abysmal that a slightly lower monthly payment isn’t ultimately enough to make a difference.

According to Fitch Ratings, a “conservative projection was that between 65% and 75% of modified subprime loans will fall 60-days or more delinquent within 12 months of the loan change.” Sure enough, the record number of loan modifications has also been accompanied by a record number of foreclosures, with “3.85% of all mortgages somewhere in the foreclosure process at the end of the first quarter, compared with 3.3% in the fourth quarter.”

Still, qualifying homeowners need not be discouraged. The flip-side of this grim statistic is that 25% of homeowners avoided foreclosure in the near-term after modifying their mortgages, right? I would encourage you to check out Making Home Affordable, HUD, and the Homeownership Preservation Foundation for more information and/or to see if you qualify.