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The refi that keeps on taking

By Holden Lewis ·
Tuesday, March 13, 2012
Posted: 8 am ET

Watch out if you refinance your mortgage under the terms of the huge mortgage servicing settlement that was filed Monday. You could end up in worse financial shape after five years.

When homeowners refinance nowadays, they almost always choose a fixed-rate loan to benefit from today's low rates. But under terms of the settlement, many borrowers will be force-fed five-year ARMs in which the interest rates are guaranteed to rise after those five years are up.

The mortgage servicing settlement was designed to redress consumer abuses by five big banks: Ally, Bank of America, Chase, Citi and Wells Fargo. These banks agreed to a legal settlement with the federal government and the attorneys general of all states except Oklahoma. The banks will pay fines without admitting wrongdoing, and they agreed to spend billions of dollars on loan modifications, short sales and refinances on loans that are not owned by Fannie Mae or Freddie Mac.

I'm not talking about HARP 2.0 refinances. Those are for mortgages owned by Fannie and Freddie. This settlement applies to mortgages that aren't owned by Fannie or Freddie.

The refinance portion of the legal settlement could yield the banks a bonanza of fees and higher interest -- at the expense of homeowners.

The legal settlement gives banks the option of refinancing mortgages with fixed rates that last for the life of the loan. But the banks have more lucrative options. Please let me know if you have ever heard of a bank choosing the less lucrative option.

Here's what would happen if you sought to refinance your loan today. I'll outline one scenario here, and a more outrageous scenario in a post later today.

Let's say you've been stuck with an underwater mortgage with an interest rate of 6.5 percent. The bank agrees to refinance your loan under terms of the legal settlement, and offers to cut your interest rate to 5.25 percent.

"Whoa! Wait a minute," you say. "My neighbor got a much lower rate than that last month." And you're right. Your neighbor got a great deal. But this legal settlement all but guarantees that you won't match your neighbor's excellent rate. For the first five years of your refinanced loan, the rate is capped at the higher of 5.25 percent or "PMMS + 100 basis points," which equalled 4.88 percent last week. (I'll explain the PMMS business in a sec.)

Under this scenario, your rate is 5.25 percent for the first five years. The bank has the option of giving you a lower rate. Do you think it will?

After five years have elapsed, your rate would rise to 5.75 percent in the sixth year, then to 6.25 percent in the seventh year, and finally to your original 6.5 percent rate in the eighth year. It would remain 6.5 percent thereafter.

The other scenario, for borrowers who now have rates below 5.25 percent, is particularly nasty. I'll explain that one this afternoon. Now I'll sketch what PMMS means.

The PMMS is Freddie Mac's weekly primary mortgage market survey, an average of mortgage rates that are offered by about 125 lenders. Last week, the PMMS was 3.88 percent. "PMMS plus 100 basis points" is 4.88 percent.

One thing the settlement doesn't answer is: What will happen if Freddie Mac doesn't exist someday? How will "PMMS + 100 basis points" be calculated then?

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April 08, 2012 at 4:01 pm

@Holden - Got the confirmation letter from WF yesterday. At least for WF I can confirm for the refi's they are simply lowering the rates to 4.25 for the remainder of the loan term. Not sure what they would do for someone in an ARM but for those in fixed loans you can know what to expect based on my experience.