Time to Refinance

The huge drop in interest rates over the past several months means you might want to be thinking about refinancing your mortgage. The average rate for a 30-year fixed-rate mortgage has dropped from a recent high of about 5.0% in November, 2018, to below 3.75% today. This is quite a drop in a short period of time, and it reflects a number of factors, including a deceleration in economic growth, decreasing inflation, and the expectation that the Fed might engage in another round of short-term interest-rate cuts very soon. But the bad news for the economy could be good news for you!

JP Morgan bank analyst Vivek Juneja wrote in a note published this morning that “based only on rates, nearly half of mortgages outstanding are estimated in the money to refi.” Of course, just because mortgage rates are now a bit lower than your current rate doesn’t mean it necessarily makes sense to refinance. There are other considerations, like the amount of the fees you will need to pay (which generally approximate 1% of the loan amount), how long you expect to stay in the home, and whether you need to pay any “points”, which are essentially a commission for the mortgage broker. But if the difference between your existing mortgage rate and current mortgage rates is large enough, you could stand to lower your monthly mortgage payment by a significant amount.

Let’s go through an example to show how valuable a mortgage refinance can be. Let’s assume that you currently have a mortgage with a $400,000 balance, which you used to buy a house last November. The rate on your mortgage is 5.0%, which was roughly the average rate during November of last year. We assume that you can obtain a new mortgage for $400,000 at a 3.75% rate, but you must be willing to pay closing costs of 1.0% of the loan and a broker fee of 0.5% of the loan. (In many case you won’t have to pay a broker fee at all, but your mortgage rate may be slightly higher.) In the chart below, we show the cumulative interest savings over the life of the new loan, assuming an up-front payment of $6,000 to cover the closing costs and broker fees (1.5% total). You will see that you are able to recover the $6,000 in fees very quickly (in month 15, to be exact). You will also see that the cumulative savings over the life of the loan grow to over $90,000. Of course, this assumes you stay in the house for the next 30 years. However, you obviously don’t have to remain in the house that long to reap significant savings. If you stay for just 10 years, for example, your cumulative savings would be over $37,000.

Source: Farr, Miller & Washington Analysis
The structure of the US mortgage market, which is significantly different than that in Canada, for example, can be very valuable for homeowners. The first advantage for US homeowners is that most mortgages offer a 30-year term at a fixed rate. The value in being able to lock in a low rate for 30 years should not be underestimated. If and when interest rates eventually go up, there is no need to worry that your mortgage payment will go up. And if we enter a period of rapidly rising incomes/wages, your discretionary income (income after expenses) could go up quite meaningfully. The second advantage is that there is generally no penalty for pre-paying conventional mortgages. The ability to pre-pay without penalties effectively means that you have a built-in option that allows you to pay off your mortgage at any time and refinance with a lower-rate mortgage. The combination of these two mortgage features means that homeowners could benefit greatly in falling interest-rate environments, like we’ve seen over the past eight months. Failure to refinance – if the numbers say it makes sense – could cost you a lot of money over the long term.
If we can be of any assistance in referring a mortgage professional please let us know. We wish everyone a safe and happy Fourth of July!