We at Arete think it is important to write about refinances at this time.
Reasons being:
Federal Reserve Chair Jay Powell recently indicated that Fed Rate drops are on the horizon.
And while there has been speculation of rate drops in the past, this time Jay Powell actually said it himself
Powell has been consistently transparent regarding the Fed’s intention for how the Money Market will be managed, especially since the Covid liquidity crisis and subsequent high inflation.
This time we think it’s true; rate drops will probably start before the presidential election, and subsequently mortgage interest will drop as well (or we’re wrong…like everyone else again).
We’re going to break down what refinancing is in the context of mortgages, why you should do it, and what we believe borrowers need to do in order to not leave money on the table.
What is Refinancing?
Refinancing is an extremely common and important component of debt management.
Essentially, refinancing is when you get a new loan to pay off an existing loan.
Most people refinance to take advantage of lower interest rates. You get a lower interest rate, which often means lower monthly payments and paying less interest over the period of the loan.
In many home mortgage markets around the world, refinancing is less common. Here are some reasons why that may be:
Most mortgage markets offer short loan periods, variable mortgage rates, and/or prepayment penalties.
With such terms, it can be much harder for a consumer to justify the closing costs of refinancing and to know they will benefit from such an action
That is not how the US mortgage market works.
The US mortgage market is truly unique:
It is dominated by long term, fixed rate, no pre-payment mortgages.
You know exactly what you are getting for the duration of the loan and how it will play out into the future.
While there is a clear benefit to the US mortgage consumer, they can also be a double-edged sword.
A fixed long term mortgage will protect you from exposure to higher interest rate markets that a variable rate mortgage would expose you to. This is nice because you always know that your payment won't go up. However, because it is fixed, without refinancing, you would not reap any benefits when interest rates go down. This can be particularly painful and costly for a holder of a long term mortgage with a high interest rate. If you don’t want to pay your bank or mortgage holder extra money every month over the life of the loan, you have to take action. Taking action is especially important if your mortgage is new since you pay more interest at the beginning of a mortgage’s amortization than the end of it.
So, what is one to do? If you don’t want to get into cost/benefit analysis about refinancing and the months to recoup the cost (totally understandable), the key is to keep it simple; it’s all just math in the end. The old simple strategies that applied in the 1980’s of ‘waiting until rates are 2% lower than your existing rate’ may have made sense with a $30,000 mortgage. But now it makes no sense to wait if you are holding a $400,000+ mortgage that you are only a few years into the term. You’d cry if you knew how much interest you paid waiting for that to happen with today’s loan amounts and rates. The strategy everyone should be deploying at the least is this:
If you can refinance your mortgage and lower your rate, by even an eighth of a percentage (say 7% to 6.875%), and you can do so with lender credits that cover the transaction fees (excluding escrow), you should do so without hesitation.
Why? Because if the market is at the point where a bank will pay you to lower your rate ; there is no downside. You lose nothing and simply gain a lower interest rate, meaning a lower payment and less interest paid, and you paid nothing to get it. Yes, you do start your mortgage amortization schedule over, but if you are wanting to maintain the same amortization schedule, it is easy enough to tack on an extra $50 or so of principal payments to your monthly payment (we’d gladly help you figure this part out). You still gain the lower minimum payment and pay less interest over time. Rates drop again? Then, you apply the same strategy again, and again, and again whenever possible. Waiting until rates ‘drop enough’ is akin to not walking away from the craps table with your gains, because if rates go up and you miss the opportunity…you’ve just lost big time and don’t know when you’ll ‘be up’ again. Keep it simple, lower your rate when you can for free, and you will have the lowest rate that was possible over any time period without worrying about your cost to recoup or other metrics necessary to justify other refi scenarios. Our most successful clients executed this strategy in the last refi market which ensured they got the lowest rate possible, as early as possible without pouring after cost comparisons to determine the benefit.
Again, the reason you need to be prepared to do this is because of how the US mortgage market works. When the market drops and offers you a lower interest rate for free, it is akin to you being able to margin call the bank on that debt. We have a unique system in the US ; it’s nationally subsidized and offers us an incredible product that no other every day people have access to. With that said, it has its tradeoffs and if you do not act to step down the interest rate ladder yourself when the opportunity arises, especially with how large loan amounts are nowadays, you are gifting quite a lot of money to the holder of your mortgage unnecessarily.
Many of you may be overwhelmed at the idea of watching the market, or perhaps you missed the refinance opportunities of 2020-2021 (though many of you did not!). So please know we are always watching the market and ready to contact clients where an opportunity exists to refinance. With that said you as the consumer can be proactive in letting us know with an email or call that you want to pursue a refinance so that we can prepare accordingly as a team. If you’ve read this far, we hope you found the information useful, and we also really appreciate you as clients that trust us to help you with your mortgage needs. Hope to hear from you soon :)