Restrict Refinancing of Home Mortgages?

A few years ago, the government and some private organizations initiated programs to enable low-income consumers to finance their purchases of homes. To make the homes affordable, mortgage interest rates were fixed as low as zero or two percent. Now, these same consumers are refinancing their mortgages at current rates, which are low historically, but certainly above two percent. In those areas where housing prices have risen, homeowners may even increase the size of their mortgages.

These developments have set off alarm bells among various consumer groups and government officials in Washington, D.C. Should not we prevent consumers from being so foolish as to refinance a zero or two percent mortgage with a seven percent mortgage? In his article in the Wall Street Journal, John Hechinger reports that the Federal Reserve Board held hearings last year and proposed a rule to prevent consumers from refinancing a no- or low-rate home mortgage loan during its first five years. ("Low" was defined as the yield on Treasury bonds of comparable maturity.) Consumer activists argued that the five-year limit was too short and that there should be no exceptions to the rule. Martin Eakes. Chief executive of Self-Help, a North Carolina credit union, is quoted: "Nobody in his right mind would refinance a zero-percent-interest, 20-year mortgage with a 14 percent to 16 percent mortgage."

On the face of it, the argument seems very simple. We need laws to protect the fool from himself. Further, the fool is risking his home, a risk he does not face on his credit card debt. However, the error in this assertion is that the critics are looking only at the marginal decision. If we look at a consumer's "portfolio" of debts, we are likely to find substantial amounts of credit card debt, with rates and late charges that far exceed the rate being paid when refinancing mortgage loans. Moreover, the monthly payments on these debts are likely to be higher than those on longer-term mortgage loan. Further, the restriction on raising more funds by refinancing a mortgage limits the ability of a homeowner to meet emergencies, such as a serious illness or to repair a damaged car.

Nevertheless, the pressure from activists and government officials against refinancing low-rate mortgage loans has been substantial and is mounting. Citigroup announced this past November that it would no longer refinance subsidized loans. Countering this trend, other lenders and the American Bankers Association have argued against limiting homeowners' flexibility in financing their needs.