On March 11, 2019, Federal Reserve Chair Jerome Powell indicated there will be no further rate hikes in 2019, even though he suggested that two were likely this year as recently as December 2018. Then in August 2019, the Fed finally cut rates for the first time in 10 years.
A rate cut is welcome news for borrowers and investors. However, declining fixed income yields is also a sign of slowing growth. The Federal Reserve does not see the economy as strong enough to withstand higher interest rates.
It’s hard to accurately predict the future. The bond market is telling us one thing and the stock market is telling us another.
But when you’ve got a bird in the hand, don’t let go. Every homeowner should at the very least refinance their mortgage now and boost cash flow.
Refinance Your Mortgage As The Yield Curve Inverts
The 10-year bond yield is now at ~1.6%, an almost 5-year low as of 2H2019 (see picture below). As recently as November 2018, the 10-year bond yield was at 3.2%. A 1.6% drop is huge, and will bring demand back into the housing market.
Given mortgage rates follow the 10-year bond yield up and down, mortgage rates are also back down to almost 5-year lows.
It doesn’t matter if the bull market continues or a recession is on the horizon now that the yield curve is inverted. Refinancing now makes a lot of sense because saving money always makes sense.
Homeowners who are seeing their adjustable rate mortgages expire within one year or homeowners who bought when rates were much higher should especially consider refinancing.
A ~1.5% decline in mortgage rates since 4Q2018 is significant.
The Adjustable Rate Mortgage Survives Again
When I bought my current house in June 2014, the 10-year bond yield was at the same level as it is today. As a result, you’d think that my 5/1 ARM would see no adjustment.
Unfortunately, my 5/1 ARM is tied to the one-year London Interbank Overseas Rate (LIBOR) plus a 2.25% spread. Given short-term rates have gone up, so will my 5/1 ARM when it adjusts this summer.
If my 5/1 ARM had been tied to the 10-year bond yield, then my mortgage rate would have stayed the same.
Instead of allowing my 5/1 ARM to reset to 4.5% from 2.5% this summer, I can simply refinance my 5/1 ARM to a new ARM at around 3%. While this rate is higher than my current 2.5% rate, it is still 0.75% – 1% lower than it was in 2H2018.
Further, an average rate of 2.75% over a 10 year period (5 years at 2.5%, 5 years at 3%) is still much lower than a 3.5% 30-year fixed rate mortgage I was considering back in 2014.
If I let my 5/1 ARM adjust this summer, my new payment would be about $3,700/month, down from $3,907/month. Why is this?
Despite the mortgage interest rate rising from 2.5% to 4.5%, my monthly payment declines because we paid down the mortgage from $990,000 to $700,000 in five years (-29%).
Paying down principal during the fixed rate period is what many ARM opponents forget about.
But the real potential cash flow savings are derived by comparing my upcoming 4.5% rate to the new 5/1 ARM rate I can get if I refinance now at 3%. In other words, my cash flow improvement is the difference between $3,700/month at 4.5% and $2,951/month at 3% = $749, a significant amount of change.
However, there is no free lunch. The appraisal, application, processing, and underwriting fees for a new mortgage may cost ~$1,700 and the title and escrow fees may cost ~$1,300 for a total of $3,000, before any credits.
One common method used by homeowners to help defray the cost of refinancing is to add the refinancing costs to the loan amount.
Note: there is no such thing as a “no-cost refinance.” If you don’t have any closing costs, the lender baked the cost into your rate.
Always Save Money When You Can
On a million dollar loan, a 0.8% – 1.375% lower mortgage rate is an annual interest savings of $8,000 – $13,750. If the cost to refinance is $3,000, you’ll have covered your cost in just 4 – 6 months.
A general rule of thumb is that you should refinance if your refinance cost is covered within 12 months. In other words if your refinance costs $3,000, your monthly interest savings should be at least $250.
The 12-month barometer is also on the condition you will live in your house for at least 13 months, preferably much, much longer. The longer you plan to live in or own your home, the more you can afford to violate the 12-month rule.
Stick to at most a maximum 24 months break even given the average homeowner lives in his or her home for only about nine years.
When it comes to refinancing, there is also a PITA factor to consider as well. You’ll have to provide your last two years of tax returns, your last two months of pay stubs, and potentially other financial documents to the bank during the underwriting process. Then you’ll need to sign a binder full of documents and set up new auto payments.
But when it comes to saving and making money, none of us should be afraid of doing a little extra work. It’s extremely easy to run the numbers once you get some legitimate quotes.
If a recession is really going to hit, we’ll be happy to be saving money each month. If the bull market continues, we’ll be absolutely ecstatic to not only be saving money but experiencing further appreciation in our beloved homes.
You can check online for the latest mortgage rates with Credible as opposed to going to each lender one by one. They have a massive mortgage lending market where they make lenders compete for your business.
Be forewarned, they are on the more aggressive side in contacting you. But when it comes to refinancing your mortgage, you want lenders who are hungriest for your business.
Then of course you should check with your existing bank who has your mortgage to see what they can provide for you. They don’t want to lose your business, so they should be incentivized to provide you the best rate possible.
Despite ~3.7% being the current average rate for a 5/1 ARM according to Freddie Mac, I’ve successfully locked in a 7/1 ARM at 2.75% worst case with zero out of pocket costs PLUS a $4,000 credit. Refinancing now is really that great of a deal.
Refinance your mortgage. Check out Credible, one of the largest mortgage lending marketplaces where lenders compete for your business. You’ll get real quotes from pre-vetted, qualified lenders in under three minutes. Credible is the easiest way to compare rates and lenders all in one place. Take advantage of lower rates by refinancing today.
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