Mortgages Blog

Finance Blogs » Mortgages Blog » The refi that keeps on taking

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?

Bankrate wants to hear from you and encourages comments. We ask that you stay on topic, respect other people's opinions, and avoid profanity, offensive statements, and illegal content. Please keep in mind that we reserve the right to (but are not obligated to) edit or delete your comments. Please avoid posting private or confidential information, and also keep in mind that anything you post may be disclosed, published, transmitted or reused.

By submitting a post, you agree to be bound by Bankrate's terms of use. Please refer to Bankrate's privacy policy for more information regarding Bankrate's privacy practices.
Holden Lewis
April 03, 2012 at 8:47 pm

Matt, it sounds like Wells is playing nice. The settlement does say that the banks have the option if giving you a low, permanent rate. It's nice of Wells to do it. The bank isn't required to.

Shan, thanks for finding that wording. "At least" includes "equal to."

April 03, 2012 at 6:25 pm

@Holden - here is the lingo from the settlement "Loan must have a current interest rate of at least 5.25 % or PMMS
+ 100 basis points, whichever is greater."

It says interest rate of at "LEAST" 5.25%. I'm also wondering how the .25 OR 100 less payment terminology works.Here is the quote:

The minimum difference between the current interest rate and the
offered interest rate under this program must be at least 25 basis points or there must be at least a $100 reduction in monthly

One interpretation is that they could refi me to 3% which would make my payment 100 less than my 5.25% interest only loan [100 less than my current payment]. Another interpretation (the likely one) is that they refi me into a 5% loan [.25% less than my current interest rate].

April 03, 2012 at 6:21 pm

@Matt - refi info as it pertains to the National Mortgage Settlement is very hard to come by.

April 03, 2012 at 11:20 am

I'm in a interest only loan at 5.25% so I believe under the settlement that they will have to make my loan at least .25% lower than my current rate because my payment will go up. Its ok - I can afford it and it is the only thing with the potential for me not to buy and bail. So it is a win win if it works out and a big loser for them if it doesn't.

April 03, 2012 at 10:58 am

Holden, Wells Fargo just finished an AG refi for me on a 30 yr 6.44% which i took out in 2007. They are lowering the rate to 4.25% for the remainder of the loan term (25 yrs remaining). I initially called them on March 2nd and they assigned me to a loan rep that day. All they required were my last two yrs W-2's. I spoke with the rep again yesterday who advised I had been approved and my future amount due would change within the next 2 payment periods. I had seen your blog this weekend which prompted me to call the rep Monday morning who assured me the rate was definitely 4.25 and would not change. Have you had any actual feedback from other individuals going through these refi's? Either Wells Fargo is lying to me or they are playing very nice.

Holden Lewis
April 03, 2012 at 9:22 am

I know this is hard to believe, but if your rate is exactly 5.25 percent, the settlement seems to leave you in limbo. It describes what banks should do with loans with rates above 5.25 percent, and what banks should do with loans with rates below 5.25 percent. But it doesn't directly address what to do about loans with rates that equal 5.25 percent. I would have spotted it if I had been one of the lawyers, and you would have spotted it. But the geniuses who put together this legal settlement either didn't notice or didn't care.

In the most generous scenario, the bank would cut your rate enough to reduce your monthly payment by $100. That reduced rate would last five years. Then it could rise. It's unclear how high it could rise -- maybe to 5.25 percent, maybe higher.

The agreement says the rate can rise to 5.25 percent or "PMMS plus 100 basis points," which today is around 5 percent, but five years from now could be north of 8 percent. Infuriatingly, the agreement doesn't specify whether the maximum rate is capped. In other words, they could have said that the max rate will be 5.25 percent or PMMS plus 100 basis points, whichever is lower. But they didn't. So as I read it, the rate could skyrocket. I'm not a lawyer, though.

Here's how I explained it last month.

April 03, 2012 at 1:54 am

So if my rate is 5.25% they will have to offer me a minimum rate of 5% for 5 years and then it can go back to 5.25%? Can I buy it down? Aren't they incentived under the settlement to provide more far reaching refi's and principal reduction?

March 13, 2012 at 6:29 pm

This is in regards to a loan with Wells Fargo that met all the criteria for refi under the terms of the AG National Mortgage Settlement on the date it was announced (2/9/2012) with an adjustable rate of 5.25%. On March 1, the rate was reduced to 5.125%. This rate adjusts every 6 months. My question...what is the effective date of this agreement? If it is March 1, isn't it ironic that the rate was adjusted down on the same date since a rate is under 5.25% does not meet one of the 10 criteria for refi.

Holden Lewis
March 13, 2012 at 4:57 pm

Brian, the rumor is that the feds and attorneys general are negotiating to get other lenders to agree to similar terms on the servicing of foreclosures, short sales and refinances. So it's possible that US Bank will offer something like this. You always have the option of making a counteroffer. Well, I hope so.

March 13, 2012 at 11:33 am

Thanks for the article. I have a similar situation with a 3yr IO that will adjust next Arpil that is tied to the 1yr LIBOR rate. Now that LIBOR's in the news, what does that mean to my mortgage? The underlying measurement may have been manipulated?

After reading this article, maybe I am happy that it doesn't apply to me. I'd like to get refinanced but my loan is owned by US Bank, not Fannie/Freddie, and not one of the big-5 lenders part of the settlement.

Of course, I am one of the people upset that these assistance programs do not apply to me.