Mortgage refinancing getting more difficult

With rates on many homeowners’ adjustable-rate mortgages rising, some who would like to refinance into a new loan are finding they can’t.

In some cases, that is because their loan carries a prepayment penalty, which would force them to come up with thousands of dollars if they refinance in the first few years. Such penalties are common with so-called option adjustable-rate mortgages, which typically carry a low teaser rate that rises sharply after an introductory period.

Other borrowers are getting caught short by a changing housing market — one in which home prices have flattened and lenders are beginning to tighten their standards after a long period of making mortgages easier and easier to get. The challenges are greatest for homeowners whose credit has declined since they took out their last loan and for those who have little if any equity. Some of these borrowers are still able to refinance but are finding it more costly than they expected.

These new challenges come at a time when many borrowers who took out adjustable-rate mortgages are facing higher payments. There are about $1.1 trillion to $1.5 trillion in ARMs that will face rate increases this year, according to the Mortgage Bankers Association. The MBA expects borrowers to refinance as much as $700 billion of those mortgages.

“The decrease in property values, combined with prepayment penalties, is making it very challenging for people to get out of these loans,” says Ed Shanks, an executive vice president with U.S. Bank Home Mortgage, a unit of U.S. Bancorp. U.S. Bank is seeing more loans fall through, particularly in markets such as Arizona, California, Colorado and Ohio, where home values have softened. It could be “the tip of the iceberg,” Shanks says.

Prepayment penalties are most common with option ARMs and loans made to borrowers with scuffed credit. Some 84 percent of option ARM loans made last year carried a prepayment penalty, according to an analysis by UBS AG that looked at mortgages that were packaged into securities and sold to investors.

The challenges facing borrowers are becoming more apparent at a time when opportunities for refinancing are narrowing. Rates on 30-year fixed-rate mortgages dropped to their lowest levels in 14 months in December, but have recently drifted higher. Rates on 30-year fixed-rate loans currently average 6.45 percent, according to HSH Associates in Pompton Plains, N.J., up from 6.16 percent in early December.

“The best deals in going from an ARM to a fixed-rate are passing,” says Doug Duncan, chief economist at the Mortgage Bankers Association. “If anything, rates are likely to move up rather than down.”

Meanwhile, there are signs that some lenders are beginning to tighten their standards. The shift comes after a long period of liberal lending practices that made it easy for borrowers to finance 100 percent of a home’s value or get a mortgage without documenting their income and assets.

In a survey released Monday by the Federal Reserve Board, roughly 15 percent of domestic banks reported that they had tightened credit standards on residential mortgage loans in the past three months, the highest share since the early 1990s.

Other homeowners are being flummoxed by lower appraisals. Those most likely to be affected bought a home or refinanced in the past year or two and have little, if any, equity. “The block to refinancing is mainly located in those areas of the U.S. where there is little or no appreciation,” says Peter Lansing, a mortgage banker in Denver.

Michelle Thompson, a medical-claims associate in North Glenn, Colo., pulled out $30,000 when she refinanced her mortgage last year, boosting her loan to $183,000. She would like to refinance again in order to lower her monthly payment, but when she went to apply for a new loan, she discovered that her mortgage debt exceeded the home’s value.