To Refinance or Not to Refinance

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Let’s do a deep dive.

 

This is typically how it goes: 

You are having dinner with your friends, chit-chatting, talking about life. Your friend, Paul, brings up refinancing his home. Suddenly, you think of your own mortgage. Is it a good time to refinance?

Later, you go home, and Google about today’s mortgage rates. The next day, you decide to give your favorite mortgage advisor a call. The debate of whether it’s the right time to refinance, or not, has begun. 

This is what I imagine my clients go through before calling me to discuss refinancing.


Where are we now?

 

 

Do you see that peak in the graph above?  That’s October 1981. The average 30-year fixed mortgage rate was at 18.45%. Now,  look at where we are today — 3.42%; it is not a secret that rates are at a historical low since April 1971.

And yet, there are still a lot of borrowers debating if this is the time to refinance. The most common reasons are: “what if the rates drop even more” and, “I heard you should only refinance when the rate is 1% lower.”

Whenever I hear the latter one, I can’t help but wonder who started it and why. Are you going to turn down saving $180 of interest a month with no costs,  because your rate did not reduce by a full percent? I wouldn’t and neither should you.

When it comes to refinancing, my point of view is always — do it if it meets your goals and benefits you.

Why? Because there are too many uncertainties and it’s impossible to predict the future correctly.  Yes, experts predict all the time; some of them are good indicators, but most of them are rarely correct. Media can be disastrous to rely on because reporting often comes too late and exaggerated facts are used to catch your eye.

COVID-19 is an excellent example of this. At the beginning of the pandemic, in the first week of March, rates dropped significantly to lowest point. However, in less than two weeks, rates had shot back up and nearly no one saw it coming.

Everyone was in panic mode. Lenders were having capacity and liquidity issues. Borrowers were losing their jobs and having problems qualifying. Lenders were tightening their guidelines; some even stopped lending altogether. Some loan programs got temporarily suspended. Loans were being canceled or declined left and right.

These aren’t exaggerated facts, these are the true stories!

So, if the opportunity presents itself, seize it. It’s always in hindsight where you realize you missed it. The easiest way to avoid missing out is simple —  don’t let it happen.

“Fear and Greed are Stronger Than Long-Term Resolve,” — Bob Farrell

If the rates are indeed better in the future, let the future you work on it. You can refinance as often as needed, as long as it meets your lender’s waiting period requirement between refinances.


So, the opportunity is here, now what?

 

Set Your Goals

It’s very much like doing anything else. You need to know why are you refinancing. Ask yourself, what you are trying to achieve and what is most important to you.

Here are some common examples:

  • Lower monthly payment
  • Lower overall interest payment
  • Remove mortgage insurance to lower monthly expenses
  • Cash-out for debt consolidation, renovation, other investments, etc.
  • Switching from an adjustable-rate to a fixed-rate to have peace of mind

Identifying what your priorities are is incredibly important. It allows you to focus on achieving your goals and avoiding going off on a tangent.

Knowing what you want can also help your mortgage advisor better structure your loan to fit your needs.

The Refinance Process

There are multiple ways to structure a refinance: no point, no fees; no point, with fees, etc. None of these are poor solutions when being used correctly.

So which one should you pick? The answer is — it depends.

Let me share an example with you.

Jane Doe

Jane bought a house in early 2018 for $500,000 with 20% down. The interest rate of her current mortgage is 4.25% and the monthly payment is $1,968. The remaining balance is $385,019, and she still has 27 years and 10 months left until it’s paid off.

Because of COVID-19, her husband got laid off, and she wants to reduce their expenses as much as possible. To achieve that, she decides to refinance her mortgage.

These are her goals:

  • Lower her monthly payment
  • Have as little out of pocket as possible, so she can have more reserves to work through this tough time

Jane’s Options

Here are 3 options for Jane:

Refinance options
This is only for illustration. Please consult your mortgage advisor for your specific situation.
  1. Scenario 1 — Lowest rate, highest out of pocket and lowest loan amount
  2. Scenario 2 — Lowest rate, lowest out of pocket and highest loan amount
  3. Scenario 3 — Highest rate, lowest out of pocket and lowest loan amount

Which scenario should Jane go with?

Assuming she will hold this loan for 11 years (median duration of homeownership in the U.S. is 13 years), here’s a diagram that shows who the winners are base on what they can achieve:

At first glance, it may seem like Scenario 1 — best loan based on cost, most monthly savings, and most interest savings — is the best for Jane.

But, remember one of Jane’s goals is to have as little out of pocket as possible? Scenario 1 requires her to fork up $3,800 in loan fees, but she needs these funds for reserves; hence, Scenario 1 is not ideal.

The diagram below shows the monthly savings for each scenario:

Although the lender will cover the loan fees for Scenario 3, without increasing the loan amount, the monthly savings are the least ideal among the 3 options.

Scenario 2 ($222 monthly savings), however, will have more monthly savings than Scenario 3 ($185 monthly savings). With the loan fees rolling into her loan, it allows her to have significantly less out of pocket as well.

She understands that her overall interest payment will be higher because of the increase in loan amount; but, her goals — to lower monthly payment and have the least amount out of pocket — can be achieved!

To Jane, Scenario 2 is her winner.

“Wait a minute, my 30-year term will have to restart.”

Yes, and no.

Some lenders are offering a lot more flexibility these days. You can refinance with flexible terms, such as 29-year, 28-year.. and it goes on.

Keep in mind: the shorter the loan term, the higher the monthly payments. Make sure you are comfortable with the monthly payments before you move forward.

If you want to have the flexibility to make a lower monthly payment but don’t want to prolong your repayment period, most lenders allow you to make additional regular principal contributions.

This will help you speed up your payoff.

Breakeven Point

It is also important to estimate how long you are planning to hold the new mortgage. Do you have plans to sell the house or refinance again anytime soon?

In our example above, Scenario 1 and 2 will take around 1.5 years to breakeven because of the initial costs of the loan. It may not be wise (unless it fits your goal), to refinance, if you are planning to pay off the loan sooner than that.

If you want to refinance and are planning on a faster pay off, Scenario 3 has an immediate breakeven point and should be considered.

To conclude

Knowing your goals can help you achieve a smoother refinancing process. Don’t let people around you affect your decision. Your friend, Paul, may have a different situation than yours. Refinance when it makes financial sense to you and meets your goals, not other people’s.

(Edited by Acayla Rushing)


Every mortgage has its own story. What’s yours? Drop me a line.

If you like my writing, subscribe to my newsletter.


Disclaimer: All information provided is for informational purposes only and does not constitute professional advice. Please contact an independent professional for advice regarding your specific situation.

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