Many applying to refinance, but few are chosen

With mortgage rates near historic lows, the number of homeowners seeking to refinance their homes has spiked to its highest level in five years.

But many have been unable to win approval for their applications. Even some homeowners who do qualify have backed off, once they found out how difficult it was to get the advertised rate.

So what should be a bright spot in an otherwise dismal economy — homeowners locking in low, fixed-rate mortgages that would free them to spend elsewhere — threatens to become another example of how even the best government intentions do not always pan out.

Mortgage rates started tumbling when the government, through its Troubled Asset Relief Program (TARP), started pumping money into banks with the goal of shoring up their balance sheets and spurring lending. It appears to be happening again as the Federal Reserve buys mortgage securities, pushing down interest rates, but not enough to bring the housing market to life.

While rates are falling, borrowers face higher costs every step of the way, from rising fees for mortgage insurance to added costs that drive up the mortgage rate. At the same time, lenders have become more cautious about who they will lend to, as more people lose jobs, watch incomes decline and fall behind on bills.

One of the biggest stumbling blocks is plunging property values, which have erased all or most of the equity in many people's homes. Others cannot meet increasingly stringent credit requirements, which either disqualify them or increase costs.

"Refinancing is a very difficult proposition right now," said Mike Stoffer, president of Stoffer Mortgage in North Canton, Ohio. "The loss of equity and tighter credit standards are making it difficult for a lot of people to refinance."

Major banks and mortgage brokers agree the number of qualified borrowers has dropped significantly. By some brokers' estimates, only 30 percent of applicants in certain markets are closing on refinancing applications. In contrast, about 60 percent of applications were approved in the first half of last year, according to the Mortgage Bankers Association.

Only a select few borrowers with pristine credit can secure the best rates: For the week that ended Thursday, the average 30-year fixed mortgage was 5.12 percent, up slightly from a record low 4.96 percent last week.

Bridging the equity gap

Earlier this decade, during the real-estate boom, many borrowers purchased homes with little or no money down, meaning that even a small drop in value could wipe out home equity. Even homeowners who initially put down 20 percent or more have seen the value of their stake fall.

As a result, many homeowners need to come up with a pile of money, essentially a new down payment, to raise their equity to at least 20 percent. Otherwise, they must buy private mortgage insurance.

But even that no longer is simple. Private mortgage insurers, which incurred large losses when the housing market collapsed, have become much more selective. They also are charging more for their service, often wiping out savings from refinancing, mortgage brokers said.

Score scrutiny

In Arizona, California, Florida and Nevada, the hardest-hit housing markets, at least two insurers are requiring borrowers to have at least 10 percent equity in their homes and a credit score of more than 720. About 48 percent of Americans have scores less than 699, according to Fair Isaac, the company that computes FICO credit scores.

On top of that, Fannie Mae and Freddie Mac, the two big mortgage guarantors now under government control, have raised the fees they charge lenders on loans that they insure or buy. Those fees are passed onto borrowers, with Fannie's latest increase about to go into effect. While the agencies always have charged more for mortgages for riskier borrowers, their fee structure has risen steadily in the past year.

Applicants with credit scores above 720 and equity of more than 20 percent in their homes still generally escape these fees. Other applicants may qualify for refinancing but must pay the higher costs.

A maze of fees

All borrowers pay a fee known as an "adverse market delivery charge" of 0.25 to 0.50 percent of the loan amount. Fannie, for example, also imposes a fee of 0.75 percent on owners of a condominium or cooperative apartment with less than 25 percent equity.

Borrowers with a home-equity loan or line of credit may pay another Fannie charge of up to 0.50 percent, depending on many factors. And borrowers who want to take cash out of their homes when they refinance — if they have enough equity — are charged up to 3 percent of the loan amount, depending on their credit score and amount of home equity.

Borrowers have a choice of paying these fees upfront or wrapping them into their mortgage rate.

"Risk-based pricing makes sense, but at the same time people are not opting to take advantage of these lower rates because they are not getting much of a benefit," said Kevin Iverson, president of Reed Mortgage in Denver.

That, he said, is "not making refinancing economically viable."

Costs vary widely

The cost of refinancing also varies greatly from lender to lender, particularly in the jumbo mortgage market, but that is because there are no investors to buy these loans.

As a result, many people have been shut out of the market. Some borrowers have jumped at the drop in mortgage rates for fixed-rate loans in hopes of refinancing out of riskier adjustable-rate mortgages. Others would like to simply free up cash.

Jim Cope, who owns a kitchen-remodeling business in Canton, Ga., falls into the second category. He and his wife, Rose Doyle, recently tried to refinance the mortgage on their home, which they purchased two years ago for $229,000. Although the couple put down 30 percent, or about $70,000, their existing lender refused to refinance the loan, which carries a rate of 6.75 percent. Cope said they were rejected because their income had dropped along with the value of their home.

"I make my payments every month, and I am not late on anything," said Cope, who, along with his wife, lost his health insurance when they were laid off from the same building company two years ago. "If people can't refinance, it will further slow down the economy."

For some borrowers, loans through the Federal Housing Administration (FHA) have become a more cost-effective option. In fact, FHA loans account for 20 percent of outstanding mortgages, up from 3 percent in 2006. "FHA is easier to work with, while conventional loans are becoming more difficult," said Stoffer, the mortgage broker. "They have kind of flipped."