Three roadblocks to a refinancing boom

August 18, 2011, 6:06 PM UTC
Fortune

FORTUNE – With mortgage rates at their lowest levels of the year, many homeowners hoping to save on monthly home loan payments have been scurrying to refinance.

Last week, rates on long-term U.S. Treasury bonds plummeted as investors spooked by debt problems in Europe and a shaky U.S. stock market sought safety in government bonds. This helped send mortgage rates, which follow Treasuries, to new lows, with 30-year-fixed rate mortgages averaging 4.32%, according to mortgage giant Freddie Mac, which tracks a weekly survey of rates.

While this hasn’t spurred many more applications for new home loans, refinancing applications surged more than 30% during the past week to their highest levels of the year, according to the Mortgage Bankers Association.

The boomlet might signal a somewhat positive sign in an otherwise dispirited housing market. But many homeowners’ finances, while improving, are still not good enough to lock in record low mortgages rates.

Here are three hurdles constraining a boom in refinances:

Home equity under siege

Most homeowners would benefit if they’re able to refinance their mortgages, but the cost savings may not amount to much at the end of a deal.

More than half of all home loans, about 67%, currently carry interest rates above 5%. However, as Gluskin Sheff chief economist David Rosenberg has pointed out, nearly half of all mortgage holders have less than 20% equity (the difference between the balance you owe on your mortgage and the value of your property) on their home.

For such homeowners, who would typically be required to buy mortgage insurance, refinancing becomes more expensive and may not be worth the costs or trouble.

Wave of conservative appraisals

During the housing boom, brokers pressured property appraisers to give overly generous appraisals, leading to fraudulent mortgages. In what seems like a reactionary move, lenders have now been pressuring appraisers to lowball their estimates, The Wall Street Journal reported earlier this week.

Because lenders typically won’t loan more than the appraised value of a home, this adds another hurdle for homeowners looking to refinance at a time when home prices have continued to fall in a troubled housing market.

This is especially bad news for the many homeowners with mortgages worth more than their properties are valued. Lenders may not be willing to grant more favorable terms if borrowers’ loan-to-value ratio does not fall within their lending guidelines.

High unemployment

Homeowners who spent too much in the years leading up to the collapse of the housing market have worked to improve their finances. In May, the average US credit score – a predictor of the likelihood lenders will be repaid – rose to 696 – the highest in at least four years, according to Equifax (EFX), which provides consumer credit data.

What’s more, the ratio to consumer-debt payments to incomes is the lowest since 1994. And during the past two years, delinquencies have dropped 30%, according to the Federal Reserve.

Needless to say, this is good news. Improved credit quality allows households to borrow more and increases homeowners’ chances of refinancing their mortgages under better terms. But even while the household deleveraging process is moving along, there is still a ways to go.

And a critical component in the refinance process is proof of income. With millions still jobless as the unemployment rate continues to hover around 9%, chances of re-negotiating mortgages at these households are much tougher.