Home Mortgage Refinancing Tips For A Smarter You

Mega MansionThe beauty of an economic downturn is cheap credit.  It’s ironic, because cheap credit is one of the main causes of this collapse in the first place!  That said, for those of you with mortgage debt, now is a great time to call your local bank and check up on rates.  Refinancing can be a daunting process, but it shouldn’t be with the right representative and proper frame of mind.

I recently refinanced one of my rental properties and now is a good time to share with you some key things to think about and assess.  Hopefully by the end of this article you will be able to make an informed decision and save lots of money as a result!

INFLATION

Knowing when to refinance is like being a bond trader.  Bond traders obsess over inflation assumptions, and you should have at least a basic assumption as well.  Clearly, there has been tremendous monetary expansion recently, which should ultimately lead to higher inflation.  Basic economic theory says that for every new $1 dollar bill printed, there will be a $1 increase in prices in the overall basket of goods eventually.  The key word is eventually, which could be decades away.

People have been waiting for higher inflation, and therefore higher rates for the past decade.  Ironically, those with short-term fixed mortgages (ARMs) are this century’s winners, because rates are resetting at equal to lower levels than when they were originally fixed!

Inflation has been coming down now for over 25 years, and I see little reason to expect inflation to suddenly jump higher given the tremendous output gap in the economy.  If inflation does start rising, at least you know that your assets are by definition also rising in nominal value.

The figure to watch is the 10-year US treasury yield.  Currently at 3.4% 2%  2.7% (as of 4/26/14) the yield is hovering close to the lows of the past decade.  Meanwhile spreads between treasury yields and bank mortgage rates have narrowed since the crisis.  Most long term duration mortgages are related to the 10-yr bond yield, hence whenever you see the stock market crashing,watch bond prices rise, and yields fall.  This is the exact time to call your mortgage broker.

DURATION

Now that you have made an assumption on inflation, you should consider matching your fixed rate duration with the time you plan to hold or pay off the loan. For example, if you plan to hold onto your property forever, but need as long a time to pay off the mortgage as possible, it behooves you to take out a 30-year fixed mortgage.  Your base case scenario is that in 30 years, you will pay off your mortgage in full, but I suggest you pay extra when you can to save on long term interest costs.

On the other hand, if you plan to only keep your property for 5 years, or plan to pay off the mortgage in 5 years, it makes more sense to take out a 5/1 ARM (adjustable rate mortgage), especially if you think inflation stays benign.

Given the yield curve is upward sloping, longer duration loans have higher interest rates.  This is a tautology for the most part, except during times of extreme economic duress, where the yield curve flattens, or inverts given people want their money as liquid as possible.  Assuming a normal upward sloping yield curve, you will pay a higher rate for a longer duration mortgage.

Current 30-yr conforming mortgage rates are roughly 4.75%-5.25% 4.25%, 3.875% while 5/1 ARMs (5 years fixed and floating thereafter) are at 4-4.25% 3.125% 2.625% as of 6/25/2012.  This is why I encourage all of you to check for the latest mortgage quote on your property for free if you have not done so in the best 6 months.  Rates have continued to go lower and you will save a lot of money!

REFINANCING COSTS

The are a bunch of costs that go into refinancing which unfortunately eat into the savings of refinancing.  The way to think about costs is to get the total cost of refinancing divided by the monthly savings of refinancing to see how many months it takes to break even.

For example, let’s say it costs $3,000 to refinance a $400,000 loan from 5.25% to 4.25%.  Your monthly payment goes from $2,375 down to $2,135 for a savings of $240.  Take the $3,000 in refinancing costs divided by $240 = 12.5.  In other words, it takes 12.5 months for you to start benefiting from a refinance.

If you plan to take 360 months (30 yr fixed) to pay off your mortgage, your actually savings would be $83,400 (347 months X $240) making the $3,000 cost to refinance a no-brainer.  Ironically, you save less if you pay off your loan quicker from a refinancing stand point.

You should also ask your broker what the cost would be to refinance at a higher rate.  In this example, you could get a “credit” to your costs if you refinanced for 4.75% instead of 4.25%, thereby having less money leave your pocket.  The general rule of thumb is that if you plan to stay in your house for over 5 years, and it costs no more than 20 months until you break even, you should refinance.

30-YEAR FIXED vs. ADJUSTABLE RATE MORTGAGES

The benefit of a 30-year fixed loan is that you know what your payments are for 30 years.  The payment will never change, only the mix between principal and interest.  As a long term fixed loan, you pay up for the “privilege” of security.

With a 5 year ARM for example, you pay a lower interest amount in exchange for not knowing what your mortgage rate will be in year 6.  Good thing is that there is generally a 5% cap increase.  The bad thing is, your payments could literally more than double going from a 4.25% interest rate in this example to 9.25%!

If you took out the 30-year fixed mortgage, in year six you will still be at 5.25%.  Hence, having a strong belief where inflation and therefore interest rates are going is important.

People think that adjustable rate mortgages are dangerous and bad.  It’s just not true.  An ARM is a wonderful option to save you money by allowing you to pay a lower interest rate if you believe inflation is benign, and if you only plan to hold the property for a shorter number of years.  ARMs generally come in 1, 3, 5, 7, and 10 year durations.

PITA FACTOR (Pain In The A** Factor)

It would be nice if one could just snap one’s fingers and change the terms of the loan.  Unfortunately, it’s not that simple and you need to spend at least 5 hours of your time speaking to your mortgage representative and preparing and signing the paperwork.  A good agent should be able to tell you all the necessary documents you need to get things going.

The process generally takes about a month given the bank needs to pay off the loan, send an appraiser to figure out the loan-to-value ratio, check your income and assets, go through the title company to get the proper documents, pull insurance records from the homeowner’s association, and get you to sign everything.

The less you make, and the less busy you are, the more you should look into refinancing!  If on the other hand, you’re happy with your loan, don’t have a lot of time, and make a ton of money, your time is worth more than the headache you will go through to save $16,000 bucks in the example above.

PUTTING IT ALL TOGETHER

If your mortgage rate is currently above 5%, consider calling your local bank’s mortgage department and asking what their latest rates are at various durations.  The phone call is free, and you will potentially save thousands over the years.

To recap: 1) ask for rates 1% lower than your existing mortgage rate, 2) match your fixed rate duration with the length you plan to pay off the loan and/or own the property, 3) Calculate the break even duration by adding up the cost of refinancing divided by the monthly savings, 4)  Consider refinances the loan if the break even duration is below 20 months (lower the better) and you plan to hold the loan for longer than 5 years.

If anything is unclear, please feel free to ask!  I’ve been involved in a dozen loans with various types of properties, and perhaps I’ll be involved with one more very soon.

Recommendations For Protecting Your Assets And Saving Money

* Check Your Credit Score: Take a moment to check your free TransUnion credit score through GoFreeCredit.com, a company I trust. 30% of credit reports have errors, which could put a serious hamper on your refinancing or new loan borrowing abilities. I had a $8 late payment I didn’t even know I owed crush my score by 100 points come up during my last refinance! The average credit score for rejected mortgage borrowers has risen to 729 due to more stringent lending requirements. Do you know what your score is? If you don’t want the credit monitoring service, simply cancel before the grace period is up.

* Refinance Your Mortgage. LendingTree Mortgage Refinance offers some of the lowest refinance rates because they have a huge network of lenders to provide mortgage loans, home equity loans, and home equity lines of credit. If you’re looking to buy a new home, consider using LendingTree to get multiple offer comparisons in a matter of minutes. When banks compete, you win.

* Manage Your Finances In One Place: The best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing and how my net worth is progressing. Their best tool is their Portfolio Fee Analyzer which is saving me more than $1,700 a year in fees I had no idea I was paying.

Regards,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. david m says

    Sam,

    Great post! Lots of good information.

    With rates historically low, I hope only very savvy people are going to take an ARM. If you can afford the higher interest rate – take an ARM – if you can not afford – take a fixed.

    • says

      Hi David, your last sentence makes an assumption that rates will be higher after the ARM resets. As we’ve seen from the past 10 years, that’s simply not true.

      I have a rate that expires next year at 4.625%, and if it had expired right now, the currently variable rate is 3.25%!

      • david m says

        It does not ASSUME that. What I’m saying is, if you can afford the fixed rate but the new higher variable rate may be a struggle, get the fixed rate.

        Additionally, I would put you in the “savvy people” group I wrote about. You probably weighed the risks and rewards before taking a variable rate mortgage. However, I think few people do/did this. That is one of the reasons we have this financial/mortgage problem.

  2. Manshu says

    I don’t know if anyone can predict inflation with any amount of certainty, I certainly can’t but with rates so low, a lot more people are interested in locking on to them for a longer duration than they were before.
    .-= Manshu´s last blog ..DHFL Fixed Deposit Plan =-.

    • says

      Nobody can predict, but I’m of the believe that if inflation has been going down/contained for 25+ years, I don’t see a sudden U turn, despite all the monetary expansion due to the massive slack in the economy.

  3. says

    Don’t do it FS! Don’t go into debt. Debt it evil. ;-)

    Seriously though, I believe inflation in the next 30 years will be higher than the previous.

    Also, we are one of the few countries that offer a 30 year fixed rate. Most others do not.
    .-= Investor Junkie´s last blog ..Weekend Reading for February 28, 2010 =-.

  4. says

    FS why not talk about your rental properties? Or maybe discuss your search for a new property? I think those topics would be interesting.

    Let me also state most of the refinance fees are a scam, especially if you go through the same bank.
    .-= Investor Junkie´s last blog ..Weekend Reading for February 28, 2010 =-.

    • says

      I am somewhat conflicted, because I enjoy building my portfolio of assets privately. As I am not one not to reveal my income or assets, it feels odd to make up figures.

      I’m paying attention to the readers, and observing the Income Poll on the right hand side. So far, 58% of readers make $85,000 and under. Therefore, I think it’s more helpful to help readers think about the basics of refinancing, rather than some prized property I want to buy. Trying to balance things out.

      I love debt, and it’s an article I will write about in the future.

      • says

        I think you can discuss details without mentioning dollar amounts. The other aspect is doy ou plan on remaining anonymous? If so, who cares then? If I’m really serious about my blog, I don’t plan on being anonymous though.

        Let me ask you this question then: If you were in their situation wouldn’t you want to get feedback from someone who’s already past their stage? It’s not about boasting.
        How did you learn about real estate investing? That could even be a topic!

        I would have *loved* getting input/advice before I purchased my first rental, a mentor. At least for me, I plan ahead. At the time, I read up on as much books I could get my hands on . Remember Carlton Sheets? :-)

        Honestly get bored with most of the other blogs out there. Mainly in my case I’m past their point. Topics about RE investing would be more interesting in at least my eyes.
        Granted you put your own spin on the common topics.
        .-= Investor Junkie´s last blog ..Weekend Reading for February 28, 2010 =-.

        • says

          I guess so. I try and be as real as possible, so ironically it feels awkward if I’m not writing with real life examples. I’m not anonymous at all, as you can see from my name Sam!

          Alrighty, I’ll keep real estate in mind for future topics.

  5. says

    Great info! I attempted to refinance from 5.75% last year and the closing cost fees caused me to scream NO! Reading your post though has me thinking that I am keeping my starter home as a vacation home and it may make sense to refinance. Great info and I’m definitely going to share this info in my non-profit for single parents. Makes sense!

    • says

      Hi Tina! Good to hear from you. Yes, if you can follow the 20 month break even rule, you should be fine. Take emotion OUT of the equation. Math doesn’t lie. Clearly, the shorter the time to break even, the better.

  6. says

    Excellent information, Sam. This is a must read for anyone even thinking about refinancing (or getting a mortgage for that matter).

    Long before the housing meltdown I had a hybrid ARM guaranteed to only go up .5% per year if there were rate changes. It was the perfect solution for me at the time because I was going to be in the home long enough to recoup my upfront costs. I don’t know if these exist anymore but would certainly be worth asking about.

    I agree with Investor Junkie, learning about your real estate investment experiences would make for interesting reading.
    .-= David @ MBA briefs´s last blog ..Exactly why you need a will =-.

    • says

      Free money for life! When bad things happen to America i.e. terrorist attacks, economic implosions, etc.. watch the long bond rocket and yields fall. That is the time to borrow money.

  7. says

    When I heard Joseph Stiglitz speaking in London a while ago (The Stig to you Sam) he raised an interesting point about fixed mortgages versus adjustable, saying that if Alan Greenspan really believed in efficient markets he’d never have urged people onto the latter — all knowledge should be in the market, so it shouldn’t be possible to take a view with the aim of getting a better deal.

    Of course The Stig doesn’t believe in 100% efficient markets, and neither do I, but it’s an interesting point.

    It leads me to conclude that your personal risk tolerance/requirements (the security you pay for with a fixed rate) is the biggest component of this particular decision.

    Of course there are people who fix at great times and people who fix at bad times. But it’s a lot easier to sleep at night knowing you could have got a better rate but being able to afford the one you did get, as opposed to the opposite.

    Anyway, great post, and I second Investor Junkie’s comments. I remember you said you were going to regret not picking up more rentals last year. Do you? ;)
    .-= Monevator´s last blog ..Buffett: Why the property bubble bursting was a good thing =-.

    • says

      Monevator, as an econ buff myself, I don’t listen to anything economists say. They preach theory, we live in the real world.

      I may have already picked up my rental, and perhaps I just haven’t written about it! :) Or maybe not. Ah, so many choices.

    • says

      E-Dog.. thanks for highlighting the site. This is a classic modern day way of doing things… punching things into calculators and telling them what they should and shouldn’t do! No problem with that, but what’s LOST is the UNDERSTANDING as to why things are so.

      This post serves to help readers looking to get a mortgage or refi THINK about why things are. We need to think more before we make big transactions, otherwise, we’ll end up taking everybody’s word for it, and imploding our economy again.

      Best, Sam
      .-= admin´s last blog ..Samurai’s Alexa Ranking Challenge Update: Progress Through Adversity =-.

  8. says

    Sam – Written like a regular mortgage guy! As a retired mortgage guy, I’d recommend against ARMs on instinct alone. Rates have behaved over the past 28 years so, yes, people who have taken ARMs have benefited. But the fact that rates are at historic lows means the upside risk is far greater than the downside potential.

    If you believe the economy will rebound, you should expect rates to rise and lock your fixed rate now. If you think rates will continue to fall, you have to be assuming the economy will get even worse, in which case you might want to stay out of real estate and even consider selling what you have. Conditions that would cause further deterioration in the economy will probably not be kind to real estate.

    A fixed rate loan gives you control of the options. If rates go up, you’re protected; if rates go down you can refinance. If you have an ARM, you’re betting rates will be lower (or at least no higher) than what they are now. With rates at historic lows, that isn’t a bet I’d be willing to take.
    .-= Kevin@OutOfYourRut´s last blog ..How Much Money Can You Save by NOT Eating Out? =-.

    • says

      Hi Kevin – Thnx! Maybe I am a mortgage guy, who knows lol.

      I was seriously considering writing another controversial article such as “Why Taking Fixed Rate Mortgages Are For Losers” or something….. b/c it has been true for the past 10 years, but nah. I don’t want to make everything controversial here.

      This article serves to help people think about the refinancing process and make their owned informed decisions.

      Although maybe I might very well follow up with that title above now that I think about it!

      Best, Sam

  9. says

    “Why Taking Fixed Rate Mortgages Are For Losers” -There are an awful lot of ex-ARM holders that are currently renting that might disagree with you. Then again we would probably all agree they shouldn’t have been in any house with any loan to begin with.

    I will second… or third… or fourth hearing about the rentals. Maybe no so much of the financial details, but I’d like to hear about the analysis, picking location, type, finding renters, managing the property etc…. (OK the money too!)
    .-= LeanLifeCoach´s last blog ..Financial Filing Systems =-.

    • says

      A’ight Greg-san, will think about it. It’s pretty straight forward and not that exciting b/c my rental portfolio is pretty straight forward. Income – Costs = cash flow. But, if you guys insist…

  10. says

    Love this post and how you added some great practical advice and concrete examples even with the admittedly generic title that is disguising a gem. BTW I would also second some of the above commentors that I would be interested to learn some more tips and tricks from your real estate investing experience. I am not interested at all really in doing any real estate investing myself as I already have close to too much on my plate with running my businesses but I have always been interested in learning from others real estate investing experiences.
    .-= Credit Card Chaser´s last blog ..Will the CARD Act Turn Credit Card Users into Payday Loan Users? =-.

    • says

      You don’t think the title “Home Mortgage Refinancing Tips” is witty and exciting?? :) Yes, I know it’s not the most interesting title, but what I wanted to do was create a non controversial post that could provide a frame work for those wishing to refinance.

      I’d like to write at least one educational type post every 2-4 weeks, so this one is it!

  11. ctreit says

    When things go bad with ARMs, interest-only mortgages, etc. we tend to think that all these financing options are bad. They are not. They all serve a purpose. Unfortunately some of these options were applied poorly. On the other hand, in years gone by we basically financed a house purchase with 30-year fixed rates and that one-size-fits-all, boring financing option has worked very well for our parents, grand-parents, and the overall economy.

    I want to add something to the worst case scenario you talk about when you discuss resets with ARMs – capped at 5%. If you finance $400,000 at 4.25%, the rate you use for a 5/1 ARM, the monthly mortgage payments are $1,945. If the rate resets to the maximum of 9.25%, the monthly payments would jump quite a bit to $3,290. Such a jump in monthly payments may break many. The good news is that an increase like that would most likely be accompanied by inflation which would then make the dollar amounts less daunting in real dollars.

    • says

      Bingo. If rates jump by 5%, it’s bc inflation is on fire and also means your asset is increasing at a healthy clip and likely your income. Everything is tied in.

      Interest only mortgages are fine too if you are happy to increase your cash flow and pay off your principal on your own schedule. It’s just educating oneself on the right way to borrow.

  12. Cynthia says

    Thanks for highlighting your thought process wrt refinancing. Very insightful, and apparent you’ve got some good experience on the situation.

    I too have a 30-yr fixed mortgage at around 5.25%. It’s amazing that variable mortgages based on index + spread are at only 3-3.25% now. Ohwell!

  13. says

    You’ve given me some thought about refinancing our own home Sam. We plan on living here for five to seven more years roughly, depending on how things go and we have a 5.75% rate right now. Our minimum payment right now is $1,360 and we pay $1,500 each month. I think if I found a rate under 5.00% it would make a lot of sense to refinance.

    • says

      It’s definitely worth calling your bank or mortgage broker to check, since the phone call is free. Spreads have narrowed, so rates have declined. Gluck!

  14. says

    I’m shopping around right now. The hassle part really gets to me with refi. That’s making my current bank’s offer more enticing to me that other places with better rates. Good luck on your efforts with the rental. If you can increase that monthly cash flow, will be a good thing, no?
    .-= PT´s last blog ..Question of the Week: Who Does Your Car Service? =-.

  15. billy says

    do you know what the market is like for refinancing a loan and keeping the interset only feature in place? or should i assume i will lose it? what will be the affect of the principal, will it trump say a 1.5% rate improvement?

  16. Casey says

    Well, it is good to know that this awful economy is beneficial to us in one way! But yes, it really is piercingly ironic that is all that to do with cheap credit in the first place. Oh well, glad to see you looking on the positive side of all this!
    .-= Casey´s last blog ..Acrylic Picture Frames =-.

  17. BG says

    “…Ironically, you save less if you pay off your loan quicker from a refinancing stand point….”

    Yes, if you only look at those variables. But if you account for the interest you are paying the bank, you will save drastically more by prepaying the loan off as fast as possible.

    Personally, I couldn’t fathom losing $308,393 in interest ($400k note @ 4.25% for 30 years). I’d rather have the house paid-and-done-for with only $91,700 lost in interest (same loan, but paid off in 10 years).

    If you are 5 years into a 30-year mortgage (25 left), then you should refinance into a 25-year or shorter note (like a 15-year). I wouldn’t want to extend my term.

  18. mortgage says

    good tips. I wish more people view this post, mortgage is the biggest spending in most people ‘s entire live, saving money on mortgage is much easier then on anything else. It saved me a lot by refinancing.

  19. says

    We are experiencing extremely cheap credit the other side of the world too, thanks to all the liquidity pouring into Asia during this period of time.

    We are typically paying 1.2% to 1.5% on the average for ARMs and about 2% for fixed. One of my colleagues just negotiated a refinanced ARM (four years fixed and floating thereafter) for 0.6%!

    By the way, I’m from Singapore, check out our housing prices! I keep wondering if we will eventually end up in a bubble as well.

    • says

      Hi Miss JJ,

      Welcome from Singapore! Wow, 0.6% rate is ridiculously low! I’m so impressed money is that cheap. Are the Indonesians and mainland Chinese buyers pouring in still?

      I can’t believe how much property prices have risen in Singapore since 2003. It used to be so cheap compared to Hong Kong!

      Curious to know how you stumbled across my site?

      Best, Sam

      • says

        Hi, Sam,

        Fortunately or unfortunately, most Asia centric finance bloggers are investment focused. Those of us who like personal finance stories almost always end up reading US/Canada blogs. I probably know your financial systems better than our own after so much reading! It was not difficult to find your blog since so many link to you.

        And yup, the mainland Chinese are still pouring into SG real estate. They have overtaken the indonesians. We know of a group of them who flies in regularly to shop for high end property with CASH. Like SGD 2 million each time. Kind of ridiculous when you stop to think about it.

        • says

          Perhaps b/c Asia is already so good at personal finance, with savings rates regularly in the 20% and higher?

          Interesting to hear the Chinese buying things up in Singapore hand over fist! Eventually, there will be resentment though, but not if you are a property owner!

  20. Norviz says

    Sam,

    You’re definitely right about needing to be a bond trader. I recently refinanced with a 30y @3.875% for no closing costs (1/8 higher rate than best available).

    You’re suggestion about a good mortgage broker is a good one. Also check with your existing bank, as many times they can offer short cuts (such as no hassle of going through the income verification again, no re-appraisal, etc.).

    Also don’t hesitate to work several deals at once, as I was able to pass on 4.5%, and 4.25% as rates dropped. With more options (and a long lead time of the process), you don’t have to worry about passing on a locked-in rate, assuming your other options are with different banks (if you decline a locked-in rate, you are usually barred from another quote for 60/90 days.) Plus if you know you have 4.25% locked in, you have a strong negotiating position with others for their best rate.

  21. Carolina says

    Hello, I need some advice. I am Curently trying to refinance on a loan that’s more then 425,00 from a 5.75 to a 3.75. My worry is that the loan is an FHA and I will be paying up. To 30,000 in PMI over the first 5 years, plus an additional 10,000 for closing fees. I am struggling right now but am afraid of wasting money and making the wrong decision. Also I have 24 years left on the current loan and am hesitant on going back to a 30 year. What to do, what to do…..

  22. says

    Thank you for giving us the information about refinancing. Refinancing can be a daunting process, but it shouldn’t be with the right representative and proper frame of mind. This will be helpful to one and all.

    Thanks,
    Anjali.

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