Mortgage Rates Are Low. Why Isn’t Everyone Refinancing?

SMITH BRAIN TRUST – The question of when to refinance is often a slightly complicated one, but with mortgage rates at years-long lows, you might think that everyone would be gathering up their documents and getting a new loan that will let them draw money out of their homes or pay them off faster.

Why aren’t they? Clifford Rossi, Professor-of-the-Practice and Executive-in-Residence at the University of Maryland’s Robert H. Smith School of Business, explores what’s happening in the world of refinancing.

Q: The Federal Housing Administration is offering an FHA Streamline Refinance, a “low-doc” refinance loan, to existing FHA mortgage holders. How does that compare with a conventional refinance loan?

Rossi: When a credit guarantor such as FHA has information on the historical performance of a loan in its portfolio, it may offer a less intensive process (e.g., waiving the need for an appraisal) to a borrower interested in refinancing their loan at a lower rate. It turns out that having a mortgage history on a borrower can be more predictive of default than other risk attributes such as income and so providing documentation relief on verification of income, assets or employment improves the borrower experience while not significantly increasing credit risk.

Q: Homeowners with government loans have been sitting on the sidelines, even as refinance rates offer potential savings. June’s Ellie Mae origination report shows FHA loan activity at just 15% refi and 21% refi for VA, compared to 68% refi activity for conventional loans. Why is that?

Rossi: There are a couple of factors at work. First, the credit profile of FHA borrowers tends to be lower than GSE-eligible loans. As a result, FHA borrowers tend to refinance at lower rates than loans guaranteed by Freddie Mac or Fannie Mae as those with better credit histories have more opportunities available from lenders. A second issue is that as the Fed began a more aggressive round of rate cuts in response to the pandemic, many borrowers have taken advantage of lower rates and so continued refinance opportunities for borrowers with relatively low mortgage rates may be less attractive to them.

Q: There are a few types of streamline refi options out there, such as the FHA streamline, the VA streamline and the USDA streamline. Could you talk about the pros and cons of each?

Rossi: Existing FHA borrowers can obtain a streamline refinance that requires a credit check and assessment of their income and capacity to repay the loan. In some cases, borrowers may be eligible for a non-credit qualifying loan that bypasses that step and may enable them to gain a lower rate than the credit-qualifying version. Borrowers going for a streamline refi need to be current on their payments and the loan needs to be at least six months old, and you still will need to come up with closing costs. For veterans with existing VA loans, the Interest Rate Reduction Refinance Loan (IRRRL) is a relatively hassle-free process, though there are some eligibility requirements similar to the FHA. For borrowers with USDA rural housing mortgages, the Streamlined-Assist Refi is a program providing less paperwork and processing than a standard mortgage application. Another benefit from these programs is that they waive the appraisal requirement, which can add time and expense to the process.

Q: How has COVID-19 affected the streamline refi process? Has it made things simpler or has it complicated the process?

Rossi: Lenders have had to adapt to the new reality of COVID-19 as they have reduced onsite staffing and made other accommodations with customer-facing activities such as mortgage application and processing. As a result, lenders and credit guarantors such as FHA are generally at full capacity to process applications and so the time to obtain a streamline refi has been extended.