Should I Refinance Now? Does A Bear Poop In The Woods?

You guys know that the one and only data point I track religiously is the 10-year yield right?  Well, after the 10 year yield dipped below 3%, I went to the bank with a buddy of mine to go see how much money we could borrow.  The wiry banker sat us down like a loving couple and asked us to go through our finances at which point I kindly stepped out of the room and let him go first.  Five minutes later, he came out with a grin on his face, so I curiously went in.

He proceeded to tell me some curious news.  “Look here Sam, you can borrow up to $1.5 million dollars at a 5 year fixed rate at 3.625%!”

Holy moly really?  You mean little old me, just like that can borrow that much money at that low of a rate?  “So what’s the catch?”, I ask.

“Zero points, and $2,500 in closing costs.  But don’t worry, we are giving you a $500 credit for being a preferred member, and frankly, if you guys both take out loans, I’ll throw in another $500 credit,” said the banker.

“Done!  Where do I sign?, I ask as I think about the new Audi R8 I plan to buy with just $150,000 of the $1.5 million.  Or maybe I should be more conservative and spend $100,000 on the new 2011 Porsche 911.  Or actually, I heard the 2011 BMW  335i coupe is coming out for only $55,000 this fall.  With all the money “saved”, time for a bachelor’s trip somewhere fun!  (I’m still thinking to myself here).

NOT SO FAST! REFINANCING SHOULD BE TO SAVE YOU MONEY

Unfortunately, things aren’t that easy.  I’m not eligible to borrow $1.5 million to buy anything.  I’m only eligible to borrow up to $1.5 million if I want to buy another piece of property or refinance my home.  Good thing I’ve got a mortgage at 4.625% to refinance, and that’s exactly what I’m going to do.

An interesting thing to note for those who have variable rate mortgages is that if it starts floating today your interest rate will be only 3.5%. But, if you can lock in for another 5 years at 3.75%, might as well do so now.

The amazing thing about this year vs. last year when the 10-yr yield was also below 3% is that banks weren’t lending.  The 10 year treasury rate actually dropped to 2.25% in October 2008 but nobody could get a loan, and if they did, spreads were egregiously wide (6% for same loan), it didn’t matter!  My how things have changed.

A QUICK REFINANCE EXAMPLE

Let’s say my mortgage is $1.5 million at 4.625% for illustrative purposes. My monthly payments would be around $7,712 a month in principal and interest.  Just by having a 10 minute conversation, and filling out some paper work with minimal cash out of my pocket, I’m able to refinance a jumbo loan of $1.5 million down to 3.75%.  The result is a $812 a month increase in cash flow as the payment drops to $6,940!

Now lets take a look at the principal and interest breakdown of $7,712 a month at 4.75%.  About $5,781 goes to interest and $1,931 goes to principal.  At a 3.75% interest rate, your monthly payment drops to $6,940 with just $4,680 in interest and a healthier $2,260 in principal!  In other words, not only do you pay less overall for better cash flow management, you pay less interest a month and more principal.

In percentage terms, even though your overall monthly payment just drops by just 10% ($7,712 a month down to $6,940) your monthly interest payment goes down 21%, and your principal payment goes up 20%.  Funny how math works.

TAKE ADVANTAGE OF THE FED’S AGGRESSIVE MONETARY POLICY

10 Year Treasury Yield Historical Chart

The refinance wave is coming again and that means more money in consumer’s pockets.  In my example above,  one has $812 extra cash to buy a new iPad every month for the next 5 years if so desired. One could also use the money to buy two round trip tickets to Hawaii, eat 15 steak dinners, lease a $60,000 automobile for no money down, or pay down more debt every month as well.  Oh the possibilities are endless!

Of course one shouldn’t start spending frivolously, but the point is there will be a consumption boom as hundreds of thousands of people across America see a nice uptick in their monthly cash flow.  Given ~68% of Americans own homes, and consumption accounts for over 60% of GDP one should feel encouraged that our economy is not going to fall off a cliff again!

Update: The 10-year yield is now at 2.4% as of 11/29/14!

Note: It’s advised to match the fixed rate portion of your loan with your intended length of ownership. In other words, if you plan on moving in 5 years, get a 5/1 ARM.  If you plan on holding your property forever, a 30-year fixed mortgage might be the way to go. Also be aware that you need a loan-to-value of 80% or less, and likely a 720+ credit score to take advantage of current low rates.  This irony of monetary policy is that it may very well benefit those who need help the least. 

Recommendations For Homebuyers Or Homeowners:

* 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?

* 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.

Updated:11/29/2014 and the 10-year yield is at ~2.4%. Rates are still very cheap.

Regards,

Sam

 

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. says

    there will be a consumption boom as hundreds of thousands of people across America see a nice uptick in their monthly cash flow.

    It’s not enough, Sam. Stocks were overvalued by $12 trillion in January 2000. Each investor’s portfolio had a nominal value of three times its real value. Most of us have been spending portions of that money for years now on all sorts of things and now the money is going “Poof!” I believe we will work through it in time (and I hope that we never, ever, ever do something like this again). But I don’t believe that a refinancing bonus can make more than a temporary difference.

    People are scared and for good reason. And the only thing that is going to get them unscared (in my view!) is straight talk about the size of the hole we have put ourselves in.

    Rob

  2. kt says

    those floating mortgage rates are what screwed people over in the last market crash. These wall street people are very good at playing people against themselves. They know people want things that they shouldn’t and cannot afford like big townhouses so they first give you interest rates that you can afford and after a year the floating rate changes to a higher number than you can afford and what comes next? mass defaults.

    I do not have a mortgage(still too young to get one) but i will make sure that my heart and mind are in the right place before taking the plunge. Something that i have come to learn is that all financial products from wall street banks are for the wall street crowd; you, john q public are just there to be seen. I havent gone through any refinancing options but i am sure there is a catch somewhere in there. i would like to know what they are planning to do with this new options because there is something they are cooking up

    • says

      Perhaps to some KT, but not to all. If you allow your mortgage rate to float right now, it’s going to float at 3.5%. I’m 100% certain that’s lower than any fixed rate 3yrs or longer that anybody has!

      In the end, there’s only ourselves to blame if we do not read contracts, and overestimate our earnings and savings. It is the coward’s way to blame others for our financial woes.

  3. says

    For me, this might be a good time to actually buy some rental property.

    I’m more in the fixed mortgage camp, but if you do the numbers correctly… why not.

    The only thing I would be afraid of is the increase in inflation, once people who start to refinance start consuming more. The higher consumption rate might drive up inflation.

    But I’m just guessing… still I’m going to start looking at properties again :)

  4. The Genius says

    I like the chart you provided ofr the 10yr yield. Why people thinking inflation is coming back after a consistent 30 year decline in rates is beyond me. The trend is our friend!

  5. says

    To refi, it really depends upon where you are currently. Not only with your existing rate, but also other goals. If someone already has a 4.75% 30 year fixed, does it make sense to refi at 4.5%? In most cases no. If you have one at 6%, what are you waiting for?

    The other factor is CAN they refi? No job = no refi. While they should, they may not be able to.

    In addition, the general public is still deliveraging and got bitten hard by this current downturn… Don’t you think they will be (even just slightly) gun shy?

    • says

      20% might not have jobs or are underemployed, but 80% too.

      It is an unintended consequence as I write in the post that those who are benefitting most from low interest rates are those who need help the least.

      I don’t think people are guy shy. People are inherently rational and greedy. Capital markets are efficient. If you want to save money you will. If you don’t want to save money, you won’t probably b/c you don’t need to. I do!

  6. says

    My, my you sure have been on a positive streak! I like the sound of people refinancing, spending money, and boosting the economy. However, I’d be more interested to know who would actually qualify for a refi in my area. So many homeowners in SoCal are underwater, I’m not so sure they’d qualify for a loan. If I were more prepared, i.e. had my down payment saved up and was sure where I wanted to live, I’d be purchasing a home right about now!

    • says

      I’m positive because I BELIEVE my eyes, and now I’m believe my pocket book with this latest cost down.

      It’s tough to refi I understand, however most people didn’t buy houses at the top of the market. And therefore, most people still have equity and can take advantage of refinancing.

      There is also a government proposed Loan Mod Hardship program for owners living in their own homes. That is working at Bank of America last I checked, so I’m optimistic!

      At the margin, lower rates help.. and should trickle down through the economy through increased spending.

    • says

      Sorry about your situation. Have you looked into a rate mod program under the government hardship plan? Just call the bank, answer a series of questions. It’s a two month process which will help you lower that 7.5% down to under 6%, I’m pretty sure of it!

  7. says

    Sam, my first question for you is how are you seeing fixed rates for 3.75%? Is this because the loan is 15 years? Or is there some other catch? The lowest rate I’ve been able to see around here is 4.5%.

    Now to answer your questions :)

    Anybody still on the fence about refinancing after reading this article?
    –> No – I want to refinance and pay the closing costs so the loan doesn’t increase, but the monthly payments do.

    Do you need a hard kick in the pants?
    –> More often than not, yes I do.

    Do you think a refinance wave is going to sweep the nation again?
    –> Probably. People want to find ways to save money in a big way these days.

    How’s the property market in your neighborhood?
    –> Here in Utah, it’s going ok I suppose. Zillow.com says our house is worth roughly 20% more than what we paid for about 6 years ago…

    • says

      Hi Jeremy,

      The 3.75% rate is for a 5/1 ARM up to $1.5 million.

      I believe people will refinance with a vengeance with these rates, thereby saving the economy from a double dip.

      Best, Sam

  8. Charlie says

    I love learning new things. I didn’t know that you need a loan-to-value of 80% or less in order to refinance. I never thought about that before but it makes a lot of sense to avoid people borrowing too much esp. if their home hasn’t been kept up and has lost a lot of value.

  9. says

    We’ll see shortly in the weekly refi data if your theory holds up. I think you’ve got a good point that the refis will help prevent the economy from going over the cliff all though you might be a bit optimistic since an inordinate amount of mortgages are in difficulty. Go back to your bank and tell them you’ve got a $1.2 million mortgage on a house worth $955,000 that you want to refi. See what they say then.
    Also, you might be a bit optimistic on the spending side. I think some people learned in the recent crisis that using a house as an ATM isn’t all that wise.

    • says

      Of course that is a problem as noted at the end of the article. All ya gotta do is refi that $1.2 million and borrow $800,000 instead and put in $300,000 in cash! Bingo!

      People don’t learn, which is what I’m counting on. People are going to blow their cash all over again, and this economy is gonna rumble!

      Just look at Apple’s earnings!

  10. says

    For a second I really thought you was going to take out a 1.5mill loan just because you could get a low rate (Yes I am a little tired so not thinking straight!).

    It absolutely makes perfect sense to refinance right now. As far as I can the economy will not drop like this for a while and refinancing will only strengthen the economy as that free cash flows a little more.

    I think the real battle is not not allow that new cash to change the way you spend right now…. A few hundred extra savings a month or an extra credit card killed will really help the next time the economy takes a little nose dive, be in 2 years or 10 years.

    • says

      It is the real battle indeed to spend on something wise, like paying down 10%+ interest rate credit card debt.

      It would be nice to take out $1.5 million for anything I pleased. I’d probably just punt it in the stock market, and see if I can get a nice 10% return, and pay it back immediately!

  11. says

    First, hilarious photo and very apropos given the title you used. I am spending some time now learning how mortgages work in Sweden. First great thing I learned: the concept of “closing costs” doesn’t exist here! I tried explaining to the bank lady how all these auxiliary companies collect a nice chunk of money on each home sale, and she just looked at me like “wtf are you yammering on about silly american”

  12. says

    Definitely a good time to be thinking about a re-fi. I’m in the process now. Just ordered my appraisal so I can prove 80% LTV. Not bad appreciation considering I borrowed 90% just a year and a half ago to buy this place. If appraisal comes through, I’ll be holding out for a 30 yr fixed rate below 4.5% with no escrow. Of course, my free cash flow will probably flow back into my mortgage since it will be my highest interest debt, but the closing costs will help the economy I guess.

  13. says

    I was picturing your brand new car and everything! Refinancing your mortgage is the next best thing I supposed. Banks won’t let you borrow money for personal indulgences…who knew.

    • says

      Yeah, maybe banks really are being diligent in assessing the lenders nowadays! It would be good to borrow the $1.5 million, blow it on a good time right before you’re about to pass away or flee the country…. perhaps :)

  14. says

    In the process of refinancing right now…going from 6.25% down to 4.375% (20 yr fixed). Interestingly enough, because of my credit score the appraisal has been waived. We are debt free except for our home so the extra couple hundred dollars saved each month will be put into college savings, so it won’t be used to ‘stimulate’ the economy.

    I do agree that refinancing is something everyone should do, but not everyone is being approved to do, due to job/credit situation. It is unfortunate, but hopefully it will be a ‘lesson learned’ when the economy finally turns around.

  15. George says

    Heh, I already refinanced 8 months ago… 3.85% 10/1 ARM, 80/20 equity with cash out… the cash out went into my investment portfolio as does the differential between my old and new monthly home payment.

    10/1 ARM is a really cool product if you currently have a 15-yr fixed mortgage at a good rate (e.g. <5%) and are trying to figure out how to maximize cashflow & profit. I was 5 years in on the 15-yr mortgage and running the numbers showed I could pay off the house in 5 years instead of 7 years. Fully expect to pay off loan in 7 years if I retire early at that time.

    10-yr fixed mortage is another option, but it doesn't signficantly improve _today's_ cashflow and I found the fees on the refi tend to negate any rate benefits.

    For what it's worth, I conservatively estimated my annual investment returns at 6.5%… as of today, my portfolio is yielding 7% in annual dividends, distributions, & royalties with a 12% YTD total return. That means that if the portfolio is only half of the mortgage size, it nearly pays the interest just in the 7% annual yield, without considering any capital gains (8.5% YTD)!

  16. says

    Refinancing a mortgage at a lower interest is not always the right decision. Multiple refinancings can reduce your overall financial benefit. Refinancing junkies who always migrate to the next low rate pay a hefty price by leaving a trail of closing costs in their wake.

  17. JimJuber says

    I am pondering whether to refi now. After a layoff two years ago, I took a job 300 miles away. I did want to sell my house because of the going prices. I bought my house in 2001, but my mortgage had only gone from 99k to 92k (one refi that rolled closing cost back into mortgage). I choose to rent my price for the last two years only clearing a profit of 100 bucks a month.

    Fast forward to today. I can refin my house on a 30 year/mortgage at 4.375 vs 5.5 rate I currently have now. Refinancing would save me close to 200 dollars a month. I can continue to rent my house for the next couple of years while clearing a bigger profit margin. This is real money in my pocket to spend OR save.

    • says

      Sounds like a no brainer to refinance now and save 1.125% in interest expense. Make sure the 200 savings a month is actually interest savings, and not just cashflow including principal since $92,000 X 1.125% is only $1,035. Divide that by 12 = $86.25 in interest savings a month.

  18. says

    I don’t think a refinance wave will hit the nation because of what you said in one of your last sentences. The irony of monetary policy is that it benefits those the most that need help the least. Most Americans do not have a credit score of 710 or above so they are not eligible to take advantage of sweet deals like the one you are getting.

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