We’ve had an uptick in the number of mortgage refinance-related conversations in our client meetings recently. The discussion always seems to center around a simple question: When is the right time to consider refinancing my existing mortgage or mortgages?While the question appears to be somewhat obvious, in actuality, it’s more complicated than simply comparing your existing rate to the current rates. Reducing your mortgage rate from the mid 4% range to the mid 3% range isn’t always a no-brainer.
As a former real estate agent and mortgage loan officer, I’m familiar with the garden variety rules of thumb regarding when to refi. They usually consist of “if you drop your rate by more than 1%, it’s a no brainer” to “if you recoup the closing costs within 12 months, it’s a no brainer,” and so on. We at Walkner Condon tend to shy away from rules of thumb, as the details of each situation and the viewpoint of each client tend to vary greatly. It’s our contention that the specific details of each situation and only the specific details, is the surefire way to know if a refinance makes sense.
With that said, here are a few of the variables we take into consideration when we are posed the mortgage questions:
- How long do you plan to stay in the house?
- What is your current mortgage rate and loan-to-value percentage?
- How long have you had your existing mortgage and what is the mortgage term?
- Does your current mortgage payment comfortably fit into your monthly budget?
- What are the closing costs and potential points to close the loan?
These questions, along with a few others, give us a great place to start in answering the question. I know it appears to be overkill. However, simply focusing on rate reduction or closing costs will not give you enough information to make a sound decision. For example, let’s say that you are able to drop your rate by 1% and the refinance would save you $100 per month on your payment. This would seem like a great decision. However, let’s say the refinance will cost you $2,000 in cost and you plan to move within the next 2-3 years. Now the decision gets a little harder. In my scenario, you will break even in 20 months, but will potentially sell the home in 24 months. Therefore, the benefit was reduced to a total of $400 of savings. Even this analysis isn’t enough to make the final decision, but it is a way to illustrate that looking at just closing costs or just at rate reduction doesn’t give you enough information.
Another common example that appears to be simple but requires a fair amount of analysis is a client who has paid their principal down to half or two thirds of the starting amount by making extra payments. For example, a borrower whose mortgage started at $300,000 with $100,000 left to pay and would like to take advantage of a lower rate environment. This scenario is challenging because we need to determine exactly how many payments are left on the existing mortgage and whether the lower rate will have a large enough impact. We also need to be careful that we don’t inadvertently stretch out the existing balance into a longer term without realizing it. A lower rate might make the borrower feel like they’ve made progress, but actually cost them more interest with a longer term.
As a last example, consider a client who receives a windfall of money and would like to make a large principal payment. Say the borrower decided to make a one-time $50,000 payment on their $200,000 mortgage with the anticipation that their monthly payments would be reduced. In this case, the mortgage would be reduced from $200,000 to $150,000, however, the rate and payment would be exactly the same the following month. To achieve a lower payment, the borrower may be able to recast their mortgage. The net effect of a recast is a lower monthly payment and potentially different terms, while not a full refinance.
We like to work in conjunction with our clients and prospective clients, their mortgage loan officer, and possibly their accountant to see if today’s refinance market presents an opportunity. If so, our analysis will help determine the correct course of action. Feel free to use us as a resource, as we are happy to run an analysis on your specific situation. Remember that making a quick decision because of a fast-moving rate environment or an overeager loan officer could end up causing more harm than good and cost you money in the end.