If you're wondering, “Should I refinance now?” The answer is was YES in 2021. But not so much in 2022 after a ~2.75% rise in mortgage rates. It's highly likely inflation will peak in 2H 2022 and head down. As a result, mortgage rates will likely head down as well by 2023.
Below are some thoughts from 2020 – 2021. There should me more real estate buying opportunities in 2023.
With so much pent-up savings and demand, surely prices are going higher as the economy reopens. Stock markets are near all-time highs. Demand for real estate is very strong as well.
If there's one asset class you should own in an inflationary environment, it's real estate. Inflation whittles down the real cost of a mortgage. Meanwhile, inflation boosts the value of real estate. This one-two combination is huge for the average person in building wealth.
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 rebounded to over 1.6%, I went to the bank with a buddy of mine to go see how much money we could borrow.
Should I Refinance Now? A Conversation With A Banker
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 2.5%!”
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 all the money I'll get to borrow.
Not So Fast! Refinance To Save
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 adjustable rate mortgages is that if it starts floating today your interest rate will be only 2.5% – 2.625%. But, if you can lock in for another 5 years at 2.5%, might as well do so now.
The amazing thing about this year vs. last year when the 10-yr yield was lower is that banks were't lending as much. The 10-year treasury rate actually dropped to 0.51% in March 2020 (2.25% in October 2008), but nobody could get a loan. If they did, spreads were egregiously wide that it wasn't profitable to refinance. Now, demand and liquidity is high.
If you can refinance your mortgage or get a new mortgage, you are in great position to take advantage of real estate deals.
Below is a chart of the latest mortgage rates. Notice how they all hit all-time lows in 2020, but are creeping up again.
A Mortgage 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 let's 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 An Aggressive Federal Reserve
Thanks to the Federal Reserve lowering the Fed Funds rate to 0% – 0.25% in 2020, mortgage rates have also declined. Mortgages follow the treasury bond market more closely. However, the Fed still has a strong effect on interest rates.
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!
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.
Invest In Real Estate More Strategically
Achieve Financial Freedom Through Real Estate
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile. The -32% decline in March 2020 was the latest example. However, real estate held steady and appreciated in value then.
Given interest rates have come way down, the value of rental income has gone way up. The reason why is because it now takes a lot more capital to generate the same amount of risk-adjusted income. Yet, real estate prices have not reflected this reality yet, hence the opportunity.
Take a look at my two favorite real estate crowdfunding platforms that are free to sign up and explore:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I've personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.