Only Half of Those Who Could Benefit From Refinancing Can Take Advantage of Low Mortgage Rates

From an article by Suzanne Kapner in today’s Financial Times, we learn that there are millions of American homeowners who could benefit from refinancing their mortgage that are unable to do so because they do not meet the lending criteria for a new mortgage (we actually knew this already, but the article has some new statistical data that is of interest).  This means that literally billions of dollars in savings that many borrowers could desperately use are being left on the table.  The article quotes a source from Barclay’s that says 87 percent of government backed mortgages have rates at least a half point higher than the average going rate, but only about half of these people are eligible for refinancing.

According to the article, there were about $1.3 trillion worth of mortgage refinancings in 2009, down from a peak of $2.5 trillion in 2003.  This is despite the fact that mortgage rates are on average about a point lower now than they were then.  The Mortgage Banker’s Association predicts that refinancing will fall to about $900 billion this year, and $370 billion in 2011.  If this prediction comes true, it could be disastrous for the mortgage industry.

There are a couple of reasons that so many borrowers are unable to refinance their mortgages.  The first and foremost reason is that declines in home values have caused massive home equity losses, leaving many borrowers owing more on their mortgage than their house is worth.  Almost 25 percent of Americans are underwater on their mortgages, and about another quarter are nearly underwater.  These people do not have the requisite loan-to-value ratios to qualify for refinancing.  If prices decline further, as many observers expect and is starting to be reflected in home price indices, even more people will be ineligible for refinance.

The second factor at play is that underwriting guidelines have tightened considerably since the housing bubble.  The no-doc, no-verification loans that caused some of today’s problems are gone, and there is an increased emphasis on underwriting standards (some might say the pendulum has gone too far in the other direction).  As credit requirements become stricter, the pool of eligible applicants is reduced.

Lastly, many Americans took a financial beating during the recession.  Credit scores across the country are down.  One quarter of Americans have middle credit scores lower than 600.  Most of these people would be ineligible for refinancing.

There are a confluence of factors that are preventing many people from taking advantage of near record mortgage rates.  Short of a turnaround in the economic fortunes of the country or underwriting policies, I don’t see a lot that can be done to change this anytime soon.