Credit, equity, and mortgage refinancings 3

When a homeowner refinances, he or she exercises the call option imbedded in the standard residential mortgage contract. In theory, a borrower will exercise this option when it is "in the money," that is, when refinancing would reduce the current market value of his or her liabilities by an amount equal to or greater than the costs of carrying out the transaction.

You Don’t Need Perfect Credit to Refinance & Save $1000s. Compare Quotes from up to 4 lenders at LowerMyBills.com

In fact, however, many borrowers with apparently in-the-money options fail to exercise them while others exercise options that apparently are not in the money. This heterogeneity of behavior appears to be due partly to differences in homeowners' ability to secure replacement financing. If an individual cannot qualify for a new mortgage, or can qualify only at an interest rate much higher than that available to the best credit risks, then refinancing may not be possible or worthwhile even though at first glance the option appears to be in the money.

Mortgage Rates Hit Record Lows! Refinance & Save $1000s.

While a decline in equity resulting from a drop in property value may rule out refinancing for some homeowners, refinancing may also not be possible or worthwhile because the homeowner's personal credit history is marginal or poor. This condition either prevents the borrower from obtaining replacement financing or raises the cost of that financing such that the present value of the benefits does not offset the transaction costs.

Guaranteed lowest cost Home Equity Loans

Not only might the interest rate available exceed that offered to individuals with perfect credit ratings, but transaction costs might also be higher. In addition to paying higher out-of-pocket closing costs, the credit-impaired borrower may be asked to provide substantially more personal financial information and may face a substantially longer underwriting process.

Home Equity Loans

Of course, other factors may explain this heterogeneity of refinancing behavior. For instance, homeowners often refinance when the option is not in the money in order to take equity out of the property. After all, mortgage debt is typically the lowest cost debt consumers can obtain, particularly on an after-tax basis.

E-LOAN Loan Center

Conversely, some homeowners who are not equity-, credit-, or income-constrained choose not to exercise options that appear to be in the money. There are several possible reasons for such behavior. For instance, a homeowner who expected to move in the near future might not have enough time to recoup the transaction costs of refinancing.

Homeowners: Been turned down recently? Refinance with Countrywide Home Loans. Click here now.

In our model of refinancing, the dependent variable is a discrete binary indicator that assumes the value of 1 when the homeowner refinances and zero otherwise. We use logit analysis to estimate the effect of various explanatory variables on the probability that a loan will be refinanced.

Bad Credit? Refinance your home to Get Cash.

The explanatory variables may be categorized as (1) market interest rates and other factors in the lending environment affecting the cost, both financial and nonfinancial, of carrying out a refinancing transaction, (2) the credit history of the homeowner, and (3) an estimate of the post-origination LTV ratio. In addition, as in most prepayment models, we include the number of months since origination (or the "age" of the mortgage) to capture age-correlated effects not stemming from equity, credit, or the other explanatory variables.