The Mortgage Professor
A Borrower With Something to Gain; Brokers With Something to Sell
Q: My house is worth $400,000, and the balance of my 5.5 percent first mortgage is $270,000. I need $50,000 to pay off debts and make some improvements. I spoke to three mortgage brokers, and all advised me to refinance my first mortgage for about $325,000. I was thinking that I would just take a second mortgage for $50,000, but the brokers all rejected that idea. What am I missing here?
A: What you are missing is that, in selecting between a cash-out refinance and a second mortgage, the broker's interest and yours may conflict. A mortgage broker might receive a fee of $3,000 or more on a $325,000 cash-out refinance but $500 or even less on a $50,000 second mortgage.
Borrowers who need cash should select the option that is least costly over the period they expect to be in their house. The most important of these factors is the interest rate on the cash-out refinance relative to the rate on the existing mortgage. If the new rate is higher, which is likely to be the case considering your 5.5 percent loan, the second mortgage probably will cost less. (One of the calculators on my Web site, http:/
Borrowers should not rely on the judgment of loan providers in making decisions about cash-out refinance. This applies not only to mortgage brokers, but also to loan officers employed by lenders. Loan officers are compensated by commission, which is calculated as a percentage of the loan amount. They have the same financial incentive as mortgage brokers to steer a customer to a cash-out refinance rather than a second mortgage.
Because of financial problems, I am unable to continue making the payments on my house. I have a lot of equity in it. The counselor I saw recommended that I sell the house and stop paying the mortgage. Do you agree?
I agree about selling the house but disagree about the advice to stop paying on your mortgage.
When you sell the house, you must deliver a clean title, which means that your mortgage, as well as any other liens, must be paid off. The unpaid interest that accrues on your mortgage will be added to the balance that you must pay. In addition, if you fall two payments or more behind, your loan will go to the collections department and incur all manner of fees, which will further swell the balance that must be repaid at closing.
On top of that, when you try to buy a house that you can afford, your credit score will be significantly lower because of your previous delinquency. This means that you will pay more for your next mortgage. In short, when you have equity to protect, stiffing the lender is a bad idea.
When I bought my home a year ago, I was told what the monthly mortgage payment would be, including taxes and insurance. It was within my budget. Recently, however, I received a notice from the escrow company, asking for an additional $165 a month for taxes. After looking into it, I found that this was not because of increased tax rates but because of a mistake the lender had made in calculating my taxes when I took out the loan. I never would have bought the house had I known how much the tax payments would be. This was the bank's error, not mine, and I can't afford this extra monthly payment. What recourse do I have?
I am not a lawyer, but I'm reasonably certain that the lender would not be held legally liable. Mistakes happen. Besides, you should have not relied on the lender to tell you what the property taxes were; prudent home buyers get that information for themselves.
That the $165 increase resulting from the lender's mistake makes the loan unaffordable for you makes me wonder whether you should have become a homeowner. You could easily have faced an equally large tax increase stemming not from a mistake but from a rate increase or rise in valuation. Such increases occur all the time. Furnaces have been known to break down the first time the buyer tries to heat the house. The universal rule of homeownership is that you will have unexpected expenses. Those who can't cope with that should remain renters.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http:/
Copyright 2007 Jack Guttentag
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