Why do rising house prices make it easier to refinance a mortgage?

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Assuming there are rising housing prices, why would it be preferable to refinance a mortgage? Why would this lead to lower interest payments than the current loan? Did the assumption that house prices would always rise contribute towards the sub-prime mess?

2 Comments
  1. Reply
    PopperDave
    May 1, 2011 at 1:13 am

    The answer to all these questions is based in the issue of the extent to which the lender’s risk is protected (secured) by the value of the property to be mortgaged. If the value has increased, even if little principle has been paid off, the lender’s exposure (measured as a percentage of the property value) is lower. On the other hand, mortgage interest rates vary in relation to other monetary trends in addition to mortgage capital supply and demand, so the available rates may be less (or more) than when the property was purchased.

    I believe it likely that a number of mortgage lenders (if not the entire industry) made loans in which their protection (secured interest) was imprudent absent an inflation in real estate prices, and that this contributed to what at this point is being called the sub-prime mess. I believe also that the imprudent lending practices are already affecting other parts of the credit markets, and that those problems will likely increase .

  2. Reply
    Kathryn
    May 1, 2011 at 1:24 am

    It’s easier to refinance a mortgage if you owe much less than the house is worth. If you buy a house for $ 200,000 with an initial mortgage of $ 180,000 and then the house appreciates to $ 300,000, it’s easy to refinance because you’ll be borrowing less than 60 percent of the appraised value of the house. If you then default, the lender will be pretty certain of getting their money back when they sell the house.

    A refinanced mortgage usually has either a lower interest rate or better terms (a fixed rather than adjustable interest rate). The only reason to refinance is if you are getting a better deal in some way.

    Yes, the assumption that housing prices would continue to rise did contribute toward the sub-prime mess. People who really couldn’t afford to buy bought anyway, using adjustable rate mortgages that they assumed they could refinance when the value of their homes went up. When the value didn’t go up, they were stuck with mortgage payments that jumped substantially when the initial interest rate ended. This led to people losing their homes, lenders losing huge amounts of money, and investors (who bought mortgage-backed securities) losing as well.

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