Advisors likely suffered from a bad case of cognitive dissonance in the wake of two opposite-end-of-the-spectrum reports this week. First, Freddie Mac said Thursday in its weekly report that mortgage rates, hit record lows for the week ended May 24, with the 30-year fixed-rate mortgage average dropping to 3.78% from 3.79% last week. Then Zillow reported in its quarterly Negative Equity Report that 31.4% of U.S. homeowners are underwater on their mortgages.
The reports raise difficult questions for advisors: What do you tell clients to do with their mortgages? Refinance? Wrap up all outstanding debt – say a home equity line of credit – into a first mortgage? Is this the right time to buy a second home? And, for clients underwater on a mortgage, what’s the plan?
A4A asked several advisors. Some advisors say the low mortgage rate environment is a chance to reduce costs or exposure to rising interest rates for clients. Other advisors see it as an opportunity to reinforce austerity spending with clients.
A Chance to Refi
“We are directing clients to evaluate refinancing when eligible,” said Ralph Adamo, president and CEO of Integrity Wealth Management.
David Zuckerman, CFP, CIMA, the chief investment officer at Zuckerman Capital Management, agrees. “I have been recommending that clients refinance existing mortgages if their existing mortgage rate is significantly higher,” he says.
Paula Nangle, CFP of The Marshall Financial Group, is advising many of her clients to refinance and “take advantage of the great low rates.”
Of course, Nangle says, there’s no one-size-fits-all solution.
One client, for instance, has two homes both with mortgage balances and a good loan-to-value ratio. There’s a line of credit on both homes, one with a balance and one with a zero balance.
For that client, Nangle recommended paying off the balance on the HELOC and closing the line of credit. Having an open line of credit, she says, would have slowed down the approval process. Plus, the client might have had to pay a higher rate on the first mortgage if the line remained open. After the refinance closes, her client will re-establish the second line of credit.
By refinancing, Nangle says, her client will save about $600 a month on mortgage payments.
Another client has a jumbo mortgage in a locale adversely affected by foreclosures and short sales. Nangle says that client would benefit from a refinance, but unfortunately the numbers didn’t work out. The appraisal came in low and the client would have had to use cash reserves to pay down the first mortgage. And, that would have “negatively impacted his liquidity and flexibility.”
In that case, Nangle recommended that the client wait to see if the real estate market improves.
And with another client who agreed to refinance, Nangle recommended that he pay down his current balance by $100,000 “because he is reluctant to invest it and has a lot of cash sitting on the side earning next to zero.”
Other advisors report applying the same sort of attention to real estate and mortgage issues.
Even though real estate prices are low, Adamo is telling clients not to buy a second home, as tempting as it may seem given the swoon in prices and the low mortgage rates. “We have not encouraged second home considerations,” says Adamo.
The same is true for Zuckerman. “I have not been recommending that clients buy second homes,” he says. “Generally speaking, a single family home is a good investment if the owner lives in it, but not a wise investment if the owner does not live in it.”
This is troubling sign to some but other advisors may see bottom. We, quite frankly, could not find any on Thursday in our unscientific effort at emailing 20 advisors.
According to Zillow, underwater homeowners owe on average $75,644 more than their house is worth. Given that the average home is worth $146,200 according to Zillow, we estimate that the average underwater homeowner has a mortgage of $221,844. What’s worse, though, is that nearly almost 5% of mortgage owners owe more than twice what their house is worth.
The good news, however, is this: While a third of homeowners with mortgages are underwater, 90% of underwater homeowners are current on their mortgage and continue to make payments, Zillow said in its release.
As for clients who owe more than their house is worth, Adamo says this: “Austerity is still a sentiment echoing in even the most affluent areas of Orange County and Newport Beach.”
For those clients who are significantly underwater, Adamo suggests tactics beyond austerity. “We are not bashful in advocating strategic defaults with short sales or even foreclosures,” he says. ”Where appropriate we are connecting clients with modification experts to renegotiate mortgage terms.
A Different Approach
Sandford (Sandy) Wollman, the president of Channel Financial Planning, shares this story. “The decision to refinance depends on the client's particular financial situation and goals,” he said. “While interest rates are historically low and refinancing may make sense for most, it is not always in the client’s best interests. For instance, if the client is over 62 and has equity in their homes, it may make sense to explore a reverse mortgage.”
According to Wollman, a reverse mortgage eliminates the monthly payment of traditional mortgages and therefor allows the client to increase their monthly income. The proceeds of a reverse mortgage can be taken either in a lump sum or as a line of credit that can be drawn down upon demand. Clients and their heirs will also benefit from the low interest rate environment with a reverse mortgage. The mortgage can be paid off after the client passes or when the home is sold. The closing cost of reverse mortgages has come down substantially in recent years making it more appealing.
“My grandmother-in-law was the perfect candidate for a reverse mortgage,” Wollman says. “She was in her mid-80s with her sole income being Social Security. Her only asset was the equity in her home. By taking out a reverse mortgage she was able to pay off her outstanding debts, have the in home care she needed and live the rest of her life with dignity in the comfort of her own home. Her heirs also benefited from the low interest rate environment. Most importantly, the reverse mortgage totally eliminated her worrying about making her ends meet. She passed away late last year and the reverse mortgage will be paid off upon the selling of her home by the executor of her estate.”
Rates in General
For the record, Freddie Mac said a 30-year fixed-rate mortgage rate was 4.60% a year earlier. To get the latest 30-year rate, payment of an average 0.8 point was required, according to Freddie Mac, a buyer of residential mortgages.
Meanwhile, the 15-year fixed-rate mortgage remained this past week at 3.04%, a record low set in the prior week. And, the average rate on the 5-year Treasury-indexed hybrid adjustable-rate mortgage held steady at 2.83%. The 1-year Treasury-indexed ARM declined to 2.75% from 2.78%.