March 20, 2020
To Refi or Not To Refi
Please read important disclosures HERE.
March 20, 2020
Please read important disclosures HERE.
Refinancing—the silver lining to the global market downturn due to coronavirus concerns. Interest rates have dropped, mortgage rates are low, and there is a historic opportunity to refinance your mortgage to possibly lower your payment, lower your total home ownership costs, and/or shorten the term of your mortgage.
On March 3, in response to the coronavirus’ potential impact to the economy and markets, the Federal Reserve cut interest rates. The move was done outside of a regularly scheduled meeting, highlighting the urgency to take action now to boost investor confidence, prevent financial conditions from worsening, and cushion the US economy from a downturn.
This rate cut has also led to lower mortgage rates, offering home owners a chance to potentially improve their short-term and long-term finances through refinancing. For instance, a year ago annual rates on a 30-year fixed-term mortgage were around 4.5 percent.1 They dropped over a percentage point to 3.29 percent as of March 5th2 which could translate to nearly $7,000/year savings on a $700,000 loan through refinancing. Mortgage rates change daily so be sure to review a current quote.
However, not everyone should refinance, even if they can. Before you rush to refinance, you need to review several factors.
What to Consider When Considering Refinancing
1. Will your rate go lower?
Review the spread between your current rate and the rate in the market. If a new rate would be at least 0.5 to one percent lower, then it would be worth looking at your refinance options.
Take into consideration that you will spend thousands on the actual refinancing. You should expect to pay somewhere between two and five percent of a loan principal in closing costs, title insurance, transfer taxes, appraisals, and any potential penalties for paying off your current loan early.
You should also factor in the time and money it will take to recover those costs. For example, if you refinance to a new 30-year loan and your monthly payment drops by only $200 (assuming $700,000 mortgage and 3.0 percent in closing costs), it will take more than 8 years to breakeven on the closing costs. However, when closing costs are low or even waived, the breakeven can be as little as 2 years. Reviewing closing costs, the potential monthly savings and the breakeven period are important consideration when evaluating whether to refinance or not.
2. Do you have enough equity in your home?
You should also bear in mind how much you have already paid into your house. Another 30-year loan might not make sense in the long-run as you might be paying more in interest. In addition, if you have paid into less than 20 percent of your equity, a creditor may require mortgage insurance.
3. Can you switch from an adjustable rate to a fixed-term mortgage?
If your current loan will start adjusting soon, what are the parameters of how it will adjust? If your adjustable-rate mortgage (ARM) would adjust to a lower rate, then you may choose to stay with your current ARM for now. On the other hand, a fixed-rate mortgage would offer you stability, making it easier to budget and provide you some protection against future interest rate increases. Bear in mind that fixed-rate loans do tend to have higher interest rates.
4. Can you adjust the loan term?
If you are already 10 or more years into your loan and you were to get a new 30-year loan, you would be paying more on interest over the long-run. That is because in the early years of your mortgage term, your payments primarily go toward paying off interest. In the later years, you begin to pay off more principal than interest and thus build more equity. Once you refinance, it’s like you’re starting over.
Say you’ve been paying off your old mortgage for 10 years, and you have 20 years left to go. If you refinance then into a new 30-year mortgage, you’re now starting at 30 years again. However, if you can shorten the length of your mortgage from 30 years to 15 years for a similar payment, it could result in a large overall cost savings.
5. How long do you plan on staying in your home?
If you plan on moving before you break even on the costs of refinancing, you might want to stay with your current mortgage.
For instance, Josh and Marina have a 30-year fixed rate mortgage of $700,00 at 4.5% and want to refinance to 3.29% like in our previous example. They bought their house in 2018 and plan to stay there for eight more years. They will break even on their refinancing costs in under three years assuming closing costs of 3%. They will also save over $40K until they sell their home eight years from now. Refinancing makes sense.
By contrast, Miguel and Noah plan to sell their home with the same 30-year fixed rate mortgage in next year so they should not consider refinancing because they will not recoup the refinancing costs.
6. Do you have a good credit score?
If your credit score or payment history have improved since your original mortgage, you might qualify for a rate that would result in a greater drop than just the current reduction.
Given the historic low rates, lenders may be overwhelmed by other home owners rushing to refinance. Be ready to provide the necessary paperwork and data in a timely fashion.
In addition, mortgage rates are constantly in flux. Know your math ahead of time and consider locking in a rate to ensure your savings while you are completing the underwriting process.
Lastly, taxpayers may be taking the standard deduction versus itemizing mortgage interest given the changes from the Tax Cuts and Jobs Act of 2018. They may not be receiving the tax benefit of having a mortgage when taking the standard deduction. These folks may consider paying off their mortgage altogether. To review some of the pros and cons of doing this, please see our previous post, “Should I Pay Off My Mortgage”.3
Whatever your ultimate decision, B|O|S is here to help you evaluate whether and how to refinance.
1. “Average U.S. mortgage size hits record-high $354,500 -MBA,” Reuters, March 12, 2019. https://www.reuters.com/article/us-usa-mortgages/average-u-s-mortgage-size-hits-record-high-354500-mba-idUSKBN1QU1VA
2. “Mortgage Rates Rise”, Freddie Mac, March 19, 2020. http://www.freddiemac.com/pmms/
3. Kevin Dorwin, “Should I Pay Off My Mortgage? New Tax Law Changes the Math for Some?” B|O|S, June 5, 2018. https://www.bosinvest.com/blog/financial-planning/pay-off-mortgage-new-tax-law-changes-math/