Higher Lending Standards: Φ Refinances

You may recall my adventures, some 18 months ago now, obtaining financing for the house we purchased when we moved from the Mountain West to the Midwest. During the last month, I went through the whole process again to drop my interest rate a full percent, from 5 7/8 to 4 7/8.

I periodically check interest rates at Realtor.com and had noticed that they had fallen since I closed on the house, but not enough to justify the usual closing costs. But December brought what seemed to be exceptionally low rates, and I was able to lock in 4 7/8 with closing costs around $3k. As a slumlord, my finances are above-average complicated, but I impressed the loan officer with the speed at which I was able to pull together financial statements, tax returns, W2s, leases -- about twenty or so documents other than the application package.

The first hurdle was the appraisal. The house had appraised in 2007 for well over what I paid, and I had paid the principal down by an additional $3k, so I thought I had plenty of cushion to absorb any drop in housing prices, pay closing costs from equity, make a 20% down payment and still walk away with some change. But alas, notwithstanding all the improvements to the house I had made, our current appraiser started with the 2007 sale price, factored in a general decline in real estate prices, and appraised the property at $9k less than what we paid.

Our loan officer told us that it's not very difficult to reduce the down payment to 15%, but we would have to pay PMI that amounts to around 7% APY on the difference, this over and above the 4.875% interest on the pricipal. Thus the effective interest rate on that money would be nearly 13%, much more than it would likely earn anywhere else. So we bit the bullet, pulled together closing costs, down payment shortfall, and escrows, and prepared to write a check for over $12k. (My escrow balance with the old lender rebates back to me, but not until two weeks after the loan closes.)

The second problem was one I had never before encountered: accounting for the down payment. The mortgage company had given us a 30-day lock on the interest rate. A week before it expired, they approached us and said, "Since the bank statement you sent us when you applied for the loan doesn't show a balance of $12k, we need to know how you intend to pay it." I sent them a screen shot of my present account balance, but they then asked for a 30 day transaction history ". . . to make sure that there are no large deposits." Well, duh! Of course there was a large deposit since I had transferred assets into the account to prepare to write them a check! Then they asked out of which account the money came and ". . . the terms of the withdrawal."

Here is where things got dicey. Other than tax-preferred accounts, most of my liquid assets are in a whole-life insurance policy. For those of you with simpler finances, a whole life policy is an insurance policy in which a portion of the premiums accumulates in the policy's "cash values". These cash values, in turn, earn dividends, so the policy works kind of like a bank account. The dividend rate can vary depending on the insurance company's profits, but the existing balance is as secure as the company itself: it cannot decrease in value unless the company tanks. At least, that is my understanding.

The problem is that the foregoing description is not necessarily how the financial world understands an insurance policy. For instance, the only way that I can actually withdraw the cash values is if I "cash out" the policy; in other words, cancel it. But I also have the option of "borrowing" the cash values at interest. So the cash values continue to earn dividends, but the interest is higher, so policy loans are wisely done only for a short term. Otherwise, cashing out the policy makes more sense.

About half of the $12k due at closing came from a policy loan, and I really, really didn't want to explain all this to the mortgage lender. In my previous mortgages, the mortage company didn't really care where the down payment came from so long as it got its money; now, however, the mortgage company seemed determined to put teeth in the prohibition against borrowing a down payment, and I was concerned that they might not get that a policy loan meant that I was "borrowing" my own money! And it didn't help that the loan came from my wife's cash values rather than mine. Indeed, I had a tense couple of days after I realized that I had endorsed and deposited a check made out to her. Would the insurance company honor the check? I was now running out of time to order a withdrawal from my own policy.

As it happened, the check was honored, I ultimately succeeded in convincing the mortgage company not to insist on looking very closely at the origin of the $6k deposit, and the loan closed successfully. Between the lower interest rate, the smaller principal, and restarting the 30-year clock, I should save about $240 per month. Still, it's clear that lenders are much more scrupulous about examining borrowers than they were a short 18 months ago.