The beauty of an economic downturn is cheap credit. And when there is a global pandemic, mortgage rates tend to go dow. As a result, every homeowner should be refinancing their mortgage right now as rates hover near all-time lows. Here are some home mortgage refinancing tips from someone who has refinanced many times.
Since 2003, I have refinanced five properties over a dozen times. These home mortgage refinancing tips are straight from experience. As a result you can pay the lowest fees and get the lowest interest rate possible.
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Refinancing can be a daunting process, but it shouldn't be with the right representative and proper frame of mind.
I refinanced my primary residence in 4Q2019 with a 7/1 ARM at 2.625% with no costs. In 2020, I got preapproved for a 7/1 ARM at only 2.125% because interest rates declined even further!
I do have relationship pricing because I've got over $1 million in assets with the lender. But even if I didn't, I could get a 7/1 ARM for only 2.5% in 2021+.
As someone who has refinanced over 10 mortgage loans since 2005, let me share with you my mortgage refinancing tips to help you get the best rate possible.
Home Mortgage Refinancing Tips To Know
Here are the most important mortgage refinancing tips you should understand before starting on your refinancing journey. Refinancing a mortgage nowadays takes longer than 10 years ago because the lending industry is more stringent.
You must have good credit, a job, and your paperwork in order if you want to successfully take advantage of low rates. With how strong the housing market will likely be, it's fantastic to be a homeowner. Not only will you experience price appreciation, but you can also lower your monthly housing costs.
1) Understand How Inflation Affects Mortgage Rates
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% 1.85% ~3.2%. 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.
2) Matching Duration Is Crucial
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 generally 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.
When the yield curve is inverted, then you should get the duration where the inversion is the steepest. Below is an example of the yield curve at three various dates. Back on August 13, 2019, you should get a mortgage duration at 5 years, 7 years, or 10 years to get the best value. Well-qualified borrowers are getting much lower mortgage rates than stated averages.
In 2020, the yield curve is still pretty flat at the 5-year to 10-year market. As a result, I think it's best to get an 5/1, 7/1, or 10/1 ARM.
3) Refinancing Costs Make A Big Difference
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 24 months until you break even, you should refinance. But I personally like to do a “no cost” mortgage refinance so that just in case I do sell the property sooner than expect, I don't lost.
4) 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.
As rates have declined post pandemic, taking out a 15-year fixed-rate mortgage is also a good idea. The average 15-year fixed-rate mortgage is now lower than the average 5/1 ARM. This is a special situation that should be taken advantage of if you have the cash flow.
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.
As we saw in the above example with the inverted yield curve, getting a 5-10-year ARM is the best choice. The average homeowner owns his or her home for only ~9 years anyway.
Don't overpay for a 30-year fixed. An adjustable rate mortgage will save you more money in this permanently low interest rate environment.
5) 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 two months on average 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.
My latest mortgage refinance in 2019 took a whopping three months to complete because there's been a huge rush to refinance as rates dropped to multi-year lows in the second half of the year.
Refinance Your Mortgage The Right Way
If your mortgage rate is currently above 4%, consider calling your local bank's mortgage department. Ask what their latest rates are at various durations. The phone call is free, and you will potentially save thousands over the years.
To recap all the home mortgage refinancing tips: 1)Aask 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! All my home mortgage financing tips are there to help you.
There is a great opportunity to buy real estate during a pandemic. Mortgage rates are at all-time lows and any seller listing now is motivated.
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Mortgage Refinancing Tips is a Financial Samurai original post.