Need a Refinance? Try a private lender

As it becomes increasingly difficult to borrow for a refinance from traditional banks, more and more consumers are turning to private lenders. While this strategy usually costs more, it involves fewer hassles and more assurances that loans will go through without delays.

With the traditional mortgage market in turmoil, many consumers who need a mortgage or refinance existing debt are turning to the private loan arena. Private lenders stepped up to the plate earlier this year to help distressed homeowners refinance when the market for jumbo loans dried up and left many jumbo note holders desperate for options. What's more, many businesses are now looking to private lenders for their commercial loans.  The reason for this is that today's economy offers a great opportunity to buy property or hire construction companies at a discounted price. Banks are tightening their purse strings and making fewer business loans, creating a larger niche for private lenders to fill.

Higher rates, faster service

Private lenders usually charge higher rates, but they can afford to because they're typically the money source of last resort. Sometimes, a borrower needs money fast in order to capitalize on a buying opportunity or complete a project on time, but conventional lenders can take up to two months to close a loan transaction. A private lender might get the same deal done within a matter of days, as long as the customer is willing to pay a premium and a hefty down payment.

An expanding market

Last year, the market for subprimes evaporated. This year, Fannie Mae will stop trading in Alt-A loans, which are one category above subprimes. This means that conventional lenders are phasing out all such loans specifically designed to help borrowers who have either poor credit, or trouble documenting income and assets. Those who normally use such loans to buy or refinance will have no choice but to turn to private lenders for help.

One of the problems for the average consumer, however, is that private loans are structured much differently than the loans that most Americans are accustomed to. A typical private loan, for example, might have a repayment life of only five to 10 years, so these loans usually need to be paid off or refinanced at a faster clip. Of course, for people planning to sell a home within a two to three year time frame, that's no problem. And for borrowers who need money for something like a home improvement project that will last just a few months, a private loan repaid in less than a year might be ideal.

Private mortgages typically charge rates of interest so high that they don't make much financial sense for the average homeowner wanting to refinance to save money in today's economic environment. But if large investors continue to pour money into the private loan sector, it will add liquidity and help to generate healthy competition. That always leads to better pricing and could ultimately benefit mortgage refinance borrowers across the board.

Second Mortgages: Making A Bad Situation Worse

Second mortgages came into vogue in a powerful way during the past few years, as borrowers were encouraged by their lenders to use them in lieu of the traditional down payment. But now, the rules have changed, and homeowners are being pushed from the skillet into the open fire.

During the most recent housing boom, huge numbers of homebuyers did something that would have been considered unthinkable in earlier years. Instead of using their savings to make a down payment on the purchase of a home, and start out with some equity on the books, they borrowed the down payment in the form of a second mortgage from their loan company.

The lender was hyper-extended by the added risk of two loans with no equity cushion to fall back on in the event of borrower default. The homeowner risked owing more than the house was worth if the market softened. Unfortunately, both scenarios happened in an industrial strength manner...and it created a trap.

No way out

The easiest way out of that mess was to refinance into a completely new first mortgage, with a better interest rate and more manageable payments. By saving money through the refinance, the homeowner could pay off the smaller second "piggyback" loan and eliminate it.

That effectively put the homeowner into a more normal financial situation that was standard business before these high-risk loan strategies came into fashion about 10 years ago. Back then, lenders typically required cash down payments of at least 10 or 15 percent for conventional loans backed by Fannie Mae, which agrees to buy mortgages that meet its underwriting guidelines.

Fannie Mae tightening belt

Then lenders got a little crazy, homeowners became more naive or reckless, and investors neglected to examine their own asset portfolios. The mortgage market imploded, and Fannie Mae is now gasping for breath. To get the wind back into its sails, it's decided to run a tighter ship by drastically altering its underwriting policies. The agency no longer permits mortgage refinancings from distressed markets (and almost all markets now fall into that category) if any of the money would be used to pay off a second mortgage.

Fannie Mae makes exceptions for borrowers who have at least 25 percent equity. But hardly anyone wanting to refinance to avoid foreclosure has that. In California, most homes have lost about 30 percent of their value in the past two years, for example, so 25 percent equity is now equal to about 5 percent negative equity. Adding insult to injury, second mortgage lenders also changed their rules, and now they require that homeowners get their consent before they can refinance a first mortgage. In other words, if you try to refinance your most burdensome mortgage, the lender may say that you first have to repay the entire second mortgage.

Scores of homeowners aren't allowed to refinance to avoid foreclosure, despite the refinance rescue rhetoric from lenders and politicians. A bad situation has only gotten increasingly worse this year, with no end in sight.