Analysis: A Mortgage Executive on Refinancing During the Economic Crisis

No one should panic. Neither scenario will occur. Moreover, the underlying mortgage market is very much alive, if not entirely well.

First, this crisis will pass. The transition may not be pretty. It may take longer than we'd like. Certain ways of doing business may be modified or eliminated. But the markets will survive, and so will every co-op. I say this with the confidence that comes from 30-plus years in the financial industry and 20-plus years of arranging underlying mortgages. In that time, I have seen three severe market contractions, and each time, the market returned to normal.

If your building does not have a pressing need for new funding, sit back and wait out the storm. If, however, you do need to refinance now, do not despair. You will get a new loan.

Far from the Subprime Crowd

It is helpful to remember that the epicenter of this crisis sits some distance from the underlying mortgage market, in the subprime sector of the single-family residential mortgage market. That is where unscrupulous loan originators processed applications from unqualified borrowers. As long as housing prices continued to rise, everyone looked the other way — appraisers, lenders, Fannie Mae, Freddie Mac, underwriting agencies and Wall Street firms, all of whom earned hefty fees from the explosion in loan volume. Once the housing bubble burst, no one could escape the consequences.

Fortunately, the vast majority of lenders offering underlying mortgages before this crisis erupted are still open and looking for business. Such names-in-the-news as Bear Stearns, Lehman Brothers, AIG, Merrill Lynch and Wachovia had little or no involvement in that market. And since Fannie Mae and Freddie Mac play important roles as buyers of underlying mortgage loans in the secondary market, their failure would have been a major blow, and so the government was forced to act, essentially nationalizing both. I fully expect continued support from both Fannie and Freddie for the underlying mortgage market.

If you do need to refinance

now, do not despair.

The biggest change you'll encounter is the run-up in spreads — the margin that lenders add to some index (usually a U.S. Treasury security). Spreads have doubled or even tripled from previous levels. So, while Treasury rates have been falling, new loan rates have not declined by much because spreads have risen. I would expect these higher spreads (190 basis points or more — that's 1.9 percent and up) to prevail until the current financial crisis subsides. However, even with these higher spreads, co-ops currently are closing new underlying mortgages with interest rates in the 5.90 to 6.50 percent range.

The second change you'll face is extreme volatility in the financial markets. A recent report from Goldman Sachs (mentioned here) notes an optimistic timeline of two years of mild recession and "painfully slow" economic growth. Until stability returns, most lenders will remain reluctant to lock the interest rate on any new loan until all underwriting issues have been addressed, all third-party reports (appraisal, engineering and environmental) have been received, all title and survey problems are resolved, and a closing is scheduled. In addition, the spread quoted in your offer letter or application could change by the time your commitment is issued — perhaps even between then and when you actually lock in your new rate.

"What do you want?" "Information."

Expect lenders to be more demanding of information about your building's financial and physical condition. Issues formerly were overlooked or given cursory attention now will get thorough evaluation. Be prepared with full explanations of deferred property maintenance, excessive shareholder arrears, serious or extensive litigation or any other significant problem, as well as the steps you're taking to remedy them. Depending on the severity of any of these issues, you might confront a higher interest rate and/or significant escrows withheld at closing to assure the lender that the problems will be addressed in the very near future.

As a consequence of these difficult times, it is critical for a co-op board to prepare thoroughly before starting the refinancing process. That preparation should include your managing agent, accountant and attorney.

Refinancing a co-op's underlying mortgage always has been one of the most significant decisions a board will make, affecting not just the monthly maintenance but also the market value of every shareholder's apartment. Mistakes during refinancing can be very costly, and missteps in a volatile, unsettled market can be disastrous. Don't despair, but do take special care.

Adapted from Habitat November 2008. For the complete article and more, join our Archive >>