Second Mortgage Subordination

As I wrote about last week, 2^nd mortgages are gumming the works for Obama’s Making Home Affordable program.  Second lien holders have to agree to subordinate their loans to the new firsts in refinancing.  And in many cases they aren’t, or are not making it easy.  The Administration was scrambling to correct this egregious oversight.  

But homeowners in Virginia have their state government to thank for a partial solution.  During the year 2000 legislative session, the General Assembly enacted a statute that, if certain conditions are satisfied, makes subordination automatic.

The most salient conditions include:  the original second mortgage must be for $50,000 or less.  The property is residential and contains no more than one dwelling unit.  The original deed of trust being refinanced was recorded prior to the subordination deed of trust.  The refinance mortgage amount is not more than $5000 than the current balance of the original mortgage.  And the interest rate of the refinance mortgage does not exceed the rate of the replaced mortgage.

The situation must meet all of these conditions and others, as well.

So this automatic process only applies to rate and term refinancing, not to cash out.

But thanks to Virginia Code § 55-58.3, subordination can happen in these instances without the lengthy delay it would otherwise entail.  A good lawyer can do it at closing.

Second Lien Roadblocks

Obama’s Making Home Affordable Plan has hit a significant speed bump for many borrowers who are depending on it to help them refinance. 

In a nutshell, many second lien holders aren’t playing nice.  They’re not readily agreeing to jump back in line behind a new first mortgage.  But why should they?

They want to get paid off.  They want to get better terms.  And they hold the trump card.

In the event of a refinance, those in second lien positions have to agree to go behind the new primary loan.  If they don’t, no bank will agree to write a new primary loan.

Second mortgages are inherently riskier than firsts.  If a house goes in foreclosure, the first lien holder calls the shots.  They’re going to auction or dispose of the property in a way that tries to get what they have in it.  They’re not too concerned about who else is in line.

What’s left gets dispersed to the second lien holder, and any one else holding a lien against the property, like a homeowners association that wasn’t getting its dues.

The greater risk, the less certainty they will get paid off in a worse case scenario, is the reason HELOCS and HELOANS typically carry higher interest rates than conventional mortgages.

And the equity loan companies have been getting hammered because people have been defaulting on them before they stop paying on their first loans. 

So they want to be taken care of, as well.

The Wall Street Journal is reporting today that this has caught the Administration by surprise.    If so, it betrays shocking incompetence in basic understanding of the mortgage business.  The bureaucrats are now scrambling to come up with a solution. 

Oops!

Investment Properties Affecting New Mortgages

Some homeowners who are looking to refinance their primary residences may find they have some difficulty qualifying for a new loan, even though little has changed in their situation of income and credit over the last year.

They may be hindered by investment property they hold.

Specifically, revised Fannie Mae guidelines apply to borrowers who instead of selling a former home to buy a new primary residence turned it into a rental property.

Fannie Mae now requires that you have at least 30% equity in that former primary residence before you can count the rental income.   This can be a hefty hurdle in today’s soft real estate market.

An investment property could’ve easily declined in value over the last three years. 

Furthermore, to show that the 30% equity value exists, borrowers will need to get an appraisal of that former property, as well as a rental analysis performed by a licensed appraiser.

As it is and was, underwriting guidelines only allow borrowers to count 75% of their rental income on investment properties.  The other 25% is ignored, chalked up to property maintenance costs and possible tenant lapses. 

But that 75% is golden when it comes to getting a new loan, even on the primary residence.  Many borrowers need to count those rent checks in their overall income.  Otherwise, their debt to income ratio (DTI) is too high to qualify for a new loan.

In this situation, the borrower may not be in any financial trouble.  They may be bringing in enough money from their salary and rental income to handle all their obligations.  But the underwriter can’t see it this way. 

She looks at the two mortgages and other debt.  And she can’t balance this with any of the borrower’s rental income.    She can’t approve the loan because the borrower, on paper, doesn’t make enough money.

Thus some borrowers trying to refinance their present home can’t qualify.

Again, this specific requirement only occurs on rental properties the borrower once resided in.  It does not apply to houses that were bought and never lived in by the owner.