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millennial mortgage shopping

Three reasons millennials don’t shop for mortgages

It never fails.  Millennial buys a home, thinks all is good in the world and only then realizes they just got taken to the cleaners on their mortgage.  They are then stuck in a loan with an unnecessarily high payment every month for years to come. How did they end up in that situation?  Why didn’t they take time to explore mortgage options?  Here are the top three reasons millennials don’t shop for mortgages.

1. “I was scared by my real estate agent”

A millennial may never admit it, but they are subject to human emotions just like the rest of us. When it comes to a big purchase, such as a home, it is human nature to want to avoid risk. Some agents take advantage of this and inject questionable statements like this:

  • “Our in-house lender is always the best.”
  • “Her service is great and she’ll be at closing, nobody else ever does that.”
  • “Those online lenders, stay away!  They’ll never close on time!”
  • “Our in-house lender will shop rates for you, you don’t need to.”

Facts: Discouraging a home buyer from mortgage shopping is 100% unethical – and could even be illegal!  There are many incredible loan originators out there and many attend closings regularly. A single lender or broker can’t shop mortgage rates for you (learn why).

To understand why a real estate agent may steer a borrower to a specific lender, let’s follow the money!

The money trail

A real estate agent makes money when a house is sold or bought via commissions. The rate and loan program obtained by the homebuyer is irrelevant to the real estate agent’s income.  Their primary goal is to get the transaction done.  Until that moment, they haven’t earned a penny.

Additionally, many real estate agents have co-marketing agreements with specific mortgage lenders, brokers or loan originators. If these mortgage professionals don’t see an ROI on their investment of marketing dollars, the real estate agent stands to lose at least part of their marketing presence.  Therefore, the real estate agent wants to “feed” the mortgage professional to continue the financially beneficial co-marketing arrangement. 

With these in mind, is it any wonder that an agent will aggressively push you to a specific lender or mortgage broker?

Not all agents are the same

While many tech disrupters offering flat fees or “no-commissions” on real estate sales solves some of the problems, one major money problem remains.  Despite the removal of commissions, real estate agents may still be receiving funds from a mortgage broker or lender in the form of a co-marketing agreement or “MSA”.  This means they will still push a homebuyer to a specific lender, robbing them of the opportunity to shop for their mortgage.

How can this problem be solved?  You simply need to find an ethical real estate agent who isn’t “hooked” on the money coming from one specific lender.  Before you legally engage with any real estate agent, simply ask this question: “Do you receive money from any specific mortgage broker or lender?”

If the answer is “yes”, walk away and find someone else who will be just as interested in helping you save money on your mortgage as they will in finding you the house of your dreams.

2. “I used an app”

Every lender claims to have the tech to close your loan faster than you can say “mortgage transaction.” Can they really?  And if they can, who is actually the winner of this perceived huge investment in technology?  Do lenders make these massive investments purely for the consumer experience?

No, they sure don’t.

Fact: The shorter your loan is in processing, the lower the likelihood you’ll shop around or be solicited by other lenders and brokers.

Avoiding competition is a good thing for mortgage lenders and brokers, but not consumers.  When a millennial decides to not consider alternatives, voluntarily or involuntarily, the lender or broker wins.  The government has been fighting to help consumers shop for years, instituting more robust disclosure time periods and new documents – but the tech industry has quickly outpaced any government intervention.

Tech helps you shop too

Fortunately, the digitization of mortgages has made mortgage shopping easier provided you can avoid the common pitfalls.

Pitfall 1: Sharing your name, email and phone number with shopping sites who send it to multiple lenders.  This will get you bombarded with calls and you’ll wish you never uttered the words mortgage.

Pitfall 2: Shopping over the course of several days.  Rates change every day, so an apples-to-apples comparison is always essential.

Pitfall 3: Shopping while uninformed.  We tend to consider the use of a mortgage concierge a good thing but hey, we may be biased 🙂

Solutions to mortgage shopping

So, how can this problem be solved?  Fair warning, the answer may require that you have a conversation with an actual human at some point who isn’t your parent or friend who doesn’t know a lick about mortgages.

Solution 1: Our particular solution is to use MortgageCS’ concierge program which is free and provides education and insights from day 1 of your shopping through your loan closing.

Solution 2: Other options are becoming a mortgage expert by holding numerous conversations with many banks, lenders, and brokers all while resisting the urge to have your credit pulled numerous times and getting bombarded with follow-up calls and emails.  Grow thicker skin and don’t be afraid to say “no” and you’ll be all set here.

3. “I am subject to advertising”

It may be hard to admit, but marketing messages can impact everyone – even tech-enabled millennials.  From TV spots to billboards and creative event sponsoring, mortgage companies are investing more and more each year to maintain scale and keep their operations growing.  After all, they have an investor base or shareholders to keep happy.

Remember this: A mortgage is a single transaction, creating a predetermined amount of income. It follows that a company with lower costs and all else equal could deliver a better mortgage rate and fee structure.  While company size and other factors can sometimes influence this, you should read this first: Do mortgage brokers act in their customers best interest?

Now that you know the three reasons millennials don’t shop for mortgages – you can ensure you don’t fall victim to the same influences!

Share this to help your friends – they can use their savings to take you to a nice dinner one day!

Compare HELOCs using a margin

Why margins matter in a HELOC

Let’s take a look at what a margin is and why margins matter in a HELOC (Home Equity Line of Credit).  For the purpose of this post on April 20th, 2018, we’ll be using the HELOC page found here.

HELOC margins range

What we see on the HELOC page is that margins can range quite a bit. In some cases, margins are as low as -1.25.  Other margins show as high as +1.00.  What does this mean when it comes to a HELOC and why is it important?

A real-world HELOC example

Let’s take a look at an analysis for a client that may be interested in obtaining a $100,000 line of credit.  Here it is:

 

In this particular analysis, we will be comparing a “High Margin” and “Lower Margin” line of credit.   In both cases, the Prime Rate is the same because it is not set by the bank.  The margin, on the other hand, is set by the bank offering the line of credit.  This is where you see a range of options.

The High Margin HELOC

The High Margin HELOC shows a margin of 0.50 percent.  When we add this number to the prime rate, we can see that our effective interest rate is 5.25%.  This interest rate will be charged until the prime rate moves up or down.  Any movement in the prime rate will simply move the Interest Rate by the same amount.

In this specific case, a client borrowing $100,000 at a 5.25% rate will need to pay $437.50 each month.

Lower Margin HELOC

When we compare the lower margin line of credit, with a margin of -1.25%, we see that the same client may end up paying just $291.67 per month.  This lower margin results in a savings of nearly $146.00 each month.

2018 Tax Rules may make this more important

Historically, any interest associated with a line of credit could be written off against income. Said another way, a homeowner who obtained a line of credit wasn’t “really” paying the interest rate they were given.  This is because they were able to deduct the interest payments from their earned income and receive a tax refund as a result.

The new tax laws starting in 2018 have changed the laws for HELOCs.  Now, there are many instances where the interest paid towards a HELOC may no longer be tax deductible. Due to this, it is more important than ever to consider savings that may be available from a HELOC with a lower margin.

HELOCs for Wealth Management Clients

Next, let’s examine a $250,000 Home Equity Line of Credit.

 

 

The same margins from above show that a savings of $364.58 is possible between a high margin HELOC and lower margin HELOC.

Cost and Shopping HELOCs

Home Equity Lines of Credit are easy to obtain and the costs to obtain them are either $0 or less than a few hundred dollars.  All else equal, it is important to understand how shopping the margins between HELOCs can have a substantial impact on monthly free cash flow.

If you’d like to evaluate lines of credit in the Philadelphia area, go here.

Home Equity Line

How does a Home Equity Line Of Credit work?

When it comes to home finance, it pays to know your options. Homeowners looking to access cash often use a Home Equity Line of Credit (HELOC, for short). How a Home Equity Line Of Credit works is different than a traditional mortgage.

Let’s take a look at how they work and what they can do for you.

What is a HELOC?

A HELOC is a common type of second mortgage. Homeowners obtaining a HELOC often have a need for additional cash.  Typical uses are debt consolidation, home remodeling or accessing cash to purchase another property.

A unique structure

HELOCs are different because they have a unique structure. For the first 10 years, the loans are in a draw period.  During the draw period, homeowners can access any portion of the available cash on demand and pay only the interest on the funds in use each month.

During a draw period, homeowners can also pay back funds at any time.  If more cash is needed, the funds which were recently paid back can be accessed again.  In this sense, a HELOC is similar to a credit card.  Different from a credit card, however, HELOCs come with relatively favorable interest rates (only slightly above traditional mortgage rates).

Adjustable rates

HELOCs also come with adjustable rates that follow the prime rate published in the Wall Street Journal. Rates can vary each month and will be impacted by the prime rate and the margin (more on margin in a moment).

When the draw period ends after 10 years, a payback period begins. During the payback period, funds can no longer be accessed from the HELOC. The outstanding balance is converted to a regularly amortizing loan spread over 20 years.  Said another way, the balance is converted to a “normal” 20-year mortgage.  At the start of the payback period, the interest rate is typically fixed and will remain so during the next 20 years.

Shopping a HELOC

Virtually all banks, lenders and credit unions will use the prime rate as the core component of determining the interest rate during the draw period.  This is called the “index.”  A bank will also set a “margin” for the draw period. Banks may offer a promotional margin for an initial period.  For example, a bank may offer “Prime minus 0.50% for 6 months, then Prime plus 0.25% onwards.”

In this case, if the prime rate is currently 5%, the initial rate will be 4.5%.  It is important to note that if prime increases, so will the effective interest rate.  The promotional margin simply reflects a relative adjustment to the published prime rate.

Why a HELOC?

There are several reasons why you may consider a HELOC over a traditional refinance.

Maintain your great interest rate

It is no secret that mortgage interest rates have increased since their historic lows.  While they may still be low, rates in the 3% range aren’t coming back anytime soon.

Homeowners looking to access additional cash may be hesitant to refinance out of their low rate – and rightfully so!  The HELOC, as a second mortgage on the property, is a great option to maintain your first loan and still gain access to cash.  As a second mortgage, the loan operates independently of any first mortgage on a property.

Low costs to obtain

The transaction costs associated with a HELOC are significantly lower than a traditional refinance. The costs of a HELOC are typically limited to an appraisal (around $350).

In contrast to a traditional refinance that involves an appraisal, title charges, lender charges and other fees, HELOCs come out as a far less expensive option.

It is worth noting that many banks offering HELOCs will also require a borrower to open a checking account. If it is not a requirement to obtain a HELOC, it is often a requirement to obtain the promotional rate.

Flexibility

The flexibility provided by a HELOC during the draw period makes them extremely advantageous. In addition to the flexibility of taking money on demand, the flexibility to pay it back and draw again is unique. This is in stark contrast to “closed-ended” mortgages (like your first mortgage) where payments are made and funds cannot be withdrawn.

Flexibility also comes in the form of lower monthly payments.  For most HELOCs, the minimum required payment is equal to the interest accrued during the prior month. In contrast to a traditional mortgage that requires interest and principal, HELOCs provide for a significantly lower payment.

HELOCs also allow some or all of the principal balance to be paid off at any time with no penalty (unless stated otherwise in their terms). This feature allows HELOC borrowers to use them for short-term cash needs – such as cash to purchase and flip a house or buy a car.

Qualifying for a HELOC

Qualifying for a HELOC is similar to most traditional mortgage products.

A homeowner looking to obtain a HELOC will need to have good credit, documented income and some type of assets for reserves. Additionally, banks will require that the total amount borrowed against the home does not exceed 80% (or in some cases 90%) of the home value.

HELOCs can be a flexible way to obtain cash without disrupting a current first mortgage. With mortgage rates inevitably rising in the future, HELOCs will certainly maintain their place as a viable home financing product.

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Refinance when rates are up

Refinance when rates are up? Maybe.

Refinancing when mortgage rates drop is usually an easy decision.  A reduction in payment and the advantages of paying less interest can make great sense.  What happens when rates increase?  Does it ever make sense to refinance when rates are up?  The answer is “maybe.”

Let’s take a look at how amortization can be used to win when rates are up.

Amortization

In addition to the interest rate and loan amount, the loan term impacts your monthly mortgage payment.  Most mortgages are spread over 30 years or 360 months.  In these cases, the loan is amortizing across 360 payments.  The shorter the amortization time, the higher the payments will be when all else is held equal.  This is because the same debt will need to be paid off in a shorter period of time.

For an extreme example, assume you pay $100,000 in 10 equal payments.  Without any interest at all, you will pay $10,000 per payment.  Whoa. When the payment schedule is set to 360 months, the amount drops to just $278.  This, again, is without factoring in interest. The same loan amount spread over more months results in a lower payment.

Amortization can benefit you

When it comes to understanding how amortization can benefit you, an example speaks mountains of truth.  Let’s examine the pros and cons by looking at the Smith family’s options.  (Note: the Smith family is fictitious in this case).

Amortization Example

The Smith’s purchased their home ten years ago.  At the time, the home was valued at 300,000 and they put $60,000 down.  As a result, they started with a $240,000 mortgage.  Their mortgage broker was able to obtain a rate of 3.5% for a 30-year mortgage.  Their monthly mortgage payment has been $1,078 for the last ten years.  This amount does not include real estate taxes or homeowners insurance.

The Smith’s have been making regular payments without contributing extra on a monthly basis. As a result, the Smith’s have $185,000 remaining to pay in the next 20 years.

Increasing cash flow with a refinance

The Smith’s have decided it may be time to refinance. They wonder if reducing their monthly mortgage payment is possible.

They learn a new mortgage at 4.375% is available. The new mortgage doesn’t require the Smith’s to pay anything out of pocket but will increase their loan to $187,000 to cover some closing costs.

If the Smith’s obtain this new loan, they’ll reduce their mortgage payment to $933, saving about $145 each month.  While the Smith’s are interested in freeing up $145 each month, they wonder what else they have to consider when increasing cash flow in this way.

Extending the loan term

In the example above, the Smiths have determined they can save nearly $150 each month if they were to refinance.  They wonder if any issues exist with extending the loan term.

Each family’s timeline and needs are unique.  As a result, there is not a single answer to this question.  Let’s examine the Smith’s again to see what they come up with.

The Smith’s have lived in their home for ten years.  Now, with children in 3rd and 4th grade, they realize they’ve got just 12 years left until they are “empty nesters.”  At that time, they plan to move to a smaller home on the coast.  In light of this family plan, the Smith’s elect to continue with the refinance transaction.

Regardless of being in their old loan or a new loan, extending the loan term is not a major concern.  This is because they plan to sell their home prior to either mortgage being paid off in full.  The Smith’s elect to save $150 each month today because that was the best choice for them.

For more on saving money on mortgages – take a look at this recent post.

 

save on your mortgage payment

Reduce your mortgage payment in 2018: 3 options

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Taking steps to improve financial wellness is a resolution for many of us. Families want to save more and spend less. Between student loan debt and cell phone bills, it can be challenging to find opportunities to save. Homeowners, however, may have several options within reach.  These are the three ways to reduce a mortgage payment in 2018.

Reduce your mortgage payment: 3 options

Want to spend less on your mortgage each month? Sure, who wouldn’t!?  There are a few ways to obtain relief.  Each option has important short and long-term considerations.

Re-cast your mortgage loan

Re-casting a mortgage restarts the mortgage term. Imagine for a moment that you have paid the first ten years of your 30-year mortgage. You will have just twenty years remaining. A recast would spread your remaining balance over thirty years rather than the current remaining term of twenty years. The result is a lower monthly mortgage payment.

Re-casting is different than refinancing.  A re-cast can only be done by the lending institution currently servicing your mortgage loan. It may involve a pre-paid interest fee or “re-cast” fee. The charge is typically far less than the cumulative fees associated with a traditional refinance transaction. Another important difference is that a re-cast will typically not require an appraisal.  For those that purchased a home at the peak of the market, this may be an important consideration.

Re-casting a mortgage loan will reset the mortgage amortization schedule.  [Why this is important] Using the example from above, you would extend your mortgage payments for ten additional years. Rather than paying your slightly higher mortgage payment for twenty years, you’ll pay a lower amount for thirty years. This can make sense for many, particularly those who are likely to move in less than twenty years.

Eliminate mortgage insurance

Mortgage insurance can be required on conventional mortgages or FHA loans. Homebuyers who currently pay mortgage insurance may be able to eliminate the requirement, saving money each month.

Homeowners interested in removing mortgage insurance must meet certain criteria. Depending on the type of loan, the current balance must be equal or less than seventy-eight or eighty percent of the home value. Said another way, homeowners will need to have at least twenty percent equity in their home. Because mortgage insurance can cost $100 or more, this can be a great way to free up cash flow.

The process of eliminating mortgage insurance involves interaction with your current servicing company. By speaking with them, you’ll learn what is needed and how much it may cost.  Your loan servicer may require an appraisal to confirm the current value of your home.  Your loan servicer may also use the value of your home at the time of purchase. Eliminating mortgage insurance is a simple way to save money each month.

Refinance your mortgage

Reducing a mortgage payment is most commonly achieved with a rate and term refinance. Homeowners will often reduce interest rates and extend loan terms providing for substantial monthly savings. Refinance mortgages are also flexible, allowing many goals to be achieved in one transaction.

The most common way to save money with a refinance is by lowering the interest rate.  All else being equal, a lower interest rate will require a lower monthly payment.  Since 2007, rates have remained relatively low which means most mortgages are already in the 3.5% to 4.5% range.  If your mortgage is in this range, you may not save money by reducing the interest rate alone.

Similar to a re-cast, refinancing into a longer term may also save you money each month in the short term. Similar to the example above, a loan extended from twenty years to thirty years will have a lower monthly payment with all else being equal. Extending the term of a mortgage can save you money each month even when the new interest rate may be higher than your current rate.

When refinancing a current mortgage, it is important to factor in the costs of the transaction as well as the long-term impacts. For example, those within twenty years of retirement may not benefit by obtaining a new 30-year mortgage loan. Additionally, a monthly savings of $50 or $75 may not be enough to warrant a rate and term refinance.  Each mortgage scenario is different, and several variables can impact the options available.

There you have it! Three ways to reduce a mortgage payment in 2018.

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Paying Off a Home Early: Calculations and Considerations

Should you make a point of paying off a home early? While it would be nice to save on interest and put monthly house payments behind you, early repayment isn’t a one-size-fits-all solution.

About Mortgages

It’s good to get a mortgage. Seriously, without the ability to finance such a large purchase, the real estate market wouldn’t be what it is today and it would instead be controlled by the very well-off.

Banks have been financing real estate since there was real estate to be purchased. Mortgages help fuel the economy in many other areas as well. When people obtain a mortgage to purchase a home, multiple parties benefit.  This can include the appraiser, the real estate agent and even home remodelers. Real estate investors in particular can benefit from the ability to finance investment properties. Mortgage interest is also one of few expenses that are tax deductible.

While the utility of a mortgage is well-defined, it is a debt. So, shouldn’t you strive to pay it off as soon as possible?

Does it make sense to aggressively pay down your mortgage loan? If so, what are the incentives for doing so? Are there any other considerations that need to be made?

If you’re like most homeowners, your monthly mortgage payment is probably your single largest recurring expense. It makes good sense to eliminate that payment and free up cash to be used for other goals such as paying off other debt, saving for college or investing for retirement.

Most mortgage loans today are amortized over 30 years, yet the reality is that few 30-year loans ever actually last that long. Mortgages are refinanced, and homes are sold long before the loans can be paid off.

In the light of this backdrop, let’s take a look at the calculations and considerations of paying a home off early.

Paying Down Pros

If you have ever looked at a mortgage amortization schedule, you understand that far more interest is paid in the early stages of a loan repayment period. If we examine a 30-year loan amount of $300,000 and use a 3.5% rate, we will see that only $472 of the $1,347 monthly payment goes towards principal in the first payment! Nearly twice as much, $875, goes towards interest in this same period.

Mortgage payments are more heavily weighted with interest than principal early on, because the interest rate is applied to the outstanding loan balance. As the mortgage is gradually paid down, the interest rate is applied to an increasingly lower loan amount.

As a result, after five years of making the mortgage payment, the outstanding loan balance has decreased by less than $40,000.  This is despite the fact that more than $80,000 in mortgage payments have been made over that same time period. At the end of five years, the loan balance is $262,234. The interest is an expense and goes to the lender, not toward the homeowner’s equity.

That’s why many borrowers make extra payments on their loans in order to send more to principal sooner and save on interest. Today, there are no prepayment penalties whatsoever on any government-backed or conventional loans. This means that anyone can pay against a mortgage at any time they choose. With an accelerated payoff, homeowner equity is increased. By how much?

Let’s take that same $1,437 payment. By making just one extra payment per year, after five years the loan balance drops to $254,245 instead of $262,234. The one extra payment made each year goes directly toward the loan balance. After 10 years of making one extra payment? The loan balance is $206,611 vs. $224,114. This math can be applied to any property type, whether it be a primary residence, a second home or an investment property. Mortgage amortization works the very same way in all cases.

Paying Down Cons

If paying down a mortgage makes sense, are there ever times when it may not be the best option?

Yes, there are a couple. With rates as low as they have been recently, you could be leveraging your borrowing costs nearly as low as they can go. When a 15-year fixed rate is in the 2.50% range or so, that’s cheap. Instead of paying down your low-interest mortgage, take a look at how your retirement fund is coming along. Yes, getting rid of your mortgage before you retire is the single biggest thing you can do, but can you have the best of both worlds?

When you retire after having devoted your extra funds to paying down the mortgage, without a healthy retirement fund you’ll be “house rich and cash poor.” You may instead be able to find investments now that will provide a higher rate of return over time, or you may want to purchase a rental property with those extra funds.

Feel Good Time

Finally, let’s admit that no longer having a mortgage and still having a safe, secure roof over your head could bring a lot of self-satisfaction. It simply feels good not to have a mortgage payment every month.- and as humans we often makes decisions based on what feels good, not what is mathematically sound.

Also, there’s no mortgage balance to pass along to your heirs when there is no mortgage. It’s an emotional advantage that other retirees may not have as they use their retirement and social security income to make the mortgage payments each month.

Finally, weighing the pros and cons of paying down a mortgage should warrant a meeting with your financial planner or wealth manager. The mortgage is typically your biggest expense and accounts for a large portion of your income. If you are considering paying down your mortgage quickly, take some time out and review your options with someone who can help you see the bigger picture and the long-term benefits and costs of being mortgage free.

“My Loan Was Sold!” (Video)

If you know your loan is going to be sold, or if you just found out it was sold, you may be wondering how it could impact your situation.

Watch this short video and find out what you really need to know:

Transcript of Video:

If you know your loan is going to be sold, or if you just found out it was sold, there is no need to panic. Lenders sell all types of loans to other banks on a regular basis. It’s part of their daily business and it’s how they ensure they can continue to make more loans in the future.

In all likelihood, your mortgage will probably change hands several times as banks buy and sell on the secondary market.

So what is this secondary market all about? And how does it impact the terms of your mortgage?

Let’s start with the impact on your loan. There’s no real impact. You have a contract that guarantees the terms of your mortgage, even after it’s sold to another lender. You may have to change the auto-payment settings on your checking account and call a different customer service number, but there won’t be any changes to any of the terms of your agreement.

Now why would a lender sell your loan in the first place? And what’s the secondary market? To answer this question you just need to remember that banks are always working to maximize their profits. And sometimes it’s better for them to sell a loan today, instead of waiting 15 or 30 years to collect small chunks in monthly payments.

Some lenders will sell a mortgage immediately after it closes, often lining up buyers while the loan is still being processed. Other lenders wait until they have a batch of loans. Then they sell them together in a single package, which bankers refer to as a “bulk” sale.

Keep in mind that the secondary mortgage market increases competition, which improves mortgage pricing and terms for you as the borrower. So the fact that your loan can be sold is a very good thing and it shouldn’t be perceived any other way.

When to Refinance, and When NOT To

Interest rates have been in their narrow range for some time now, after hitting record lows in late 2012. The average 30 year fixed rate hit 3.31% that year according to Freddie Mac’s weekly mortgage rate survey.

You may not be able to find a 3.31% rate today (at least without paying additional fees), but you can still get very close considering the recent few decades of interest rates. Many homeowners have taken advantage of lower rates and refinanced their mortgages to enjoy lower monthly payments, but there are still more who, for whatever reason, haven’t decided whether or not a refinance makes sense.

There are ways to know whether a refinance is a good idea, and it’s not always about the interest rate. Here are some basics to keep in mind when considering a new mortgage:

Interest Rate & Payment

This is the most common reason people refinance. When mortgage rates fall, homeowners soon see solicitations from mortgage lenders announcing the new opportunity to lower their monthly payments. While that certainly makes sense in many cases, it’s not the right solution for everyone, every time. You may have heard it’s a good idea to refinance if rates are say, 1.00% below what you currently have, but the rate is only part of the equation. If you have a 30-year fixed rate of 5.00% and rates fall to 4.00%, then that so-called “rule of thumb” would kick in. But that’s not the only consideration when evaluating a possible refinance.

Instead, you must first weigh the difference in monthly payments compared against the fees associated with getting the new mortgage, then determine how long it would take to recover those closing costs. Let’s look at a basic example. Let us suppose that you have a mortgage balance of $200,000 and a 30-year fixed rate at 4.00%. That puts your current monthly principal and interest payment at $954 per month.

Now imagine interest rates have fallen to 3.25%. The new monthly payment would fall to $870, for a monthly savings of $84 each month. That’s an attractive number, but how much will it cost to get that lower rate? Let’s say that lender fees are $1,000, and other third party charges add up to $3,000 for a $4,000 total. If you divide the monthly savings into the closing costs you get 47.62, or almost 48 months to recover those fees with the lower payment. Is that too long?

Possibly. Some think a recovery term of two to three years makes the most sense, and if you’re going to own the property for at least that long, then a refinance might be a good idea. When refinancing a mortgage because rates are lower, you must also consider the costs involved.

Note: It is also important to consider the costs of re-amortizing (or starting over) on your loan term. These details are not covered in this particular article –however here is a brief: If you are two years into a 30-year loan and refinance into another 30-year loan, you are resetting the 30-year period, meaning you have 30 more years to pay your new amount compared to just 28 years of paying the older mortgage payment.

To reduce costs, it is a popular option to obtain a lender credit at the time of closing. Mortgage companies are typically willing to increase your interest rate in exchange for lower closing costs. Using the example from above, if you increased the new rate from 3.25% to 3.50%, the monthly payment would still be $56 lower. At the same time, the lender would provide you with a credit of $2,000, or 1% of the loan amount. In this instance, the time it would take to recover your closing costs will be under three years, or 35 months- certainly a more attractive option.

If you are wondering how this works, you are not alone. In the same fashion that you can lower a 30-year fixed rate by paying discount points, you can also select to increase your interest rate and have the lender pay some of your costs in the form of a lender credit. Mortgage lenders have no preference on which option you take – so explore your options before making a final decision.

Changing Loan Terms

Another popular reason to refinance is to shorten the term of an existing loan. Reducing the term of a mortgage loan saves a considerable amount of interest, yet it also typically increases the monthly payment. Most borrowers opt for a 30-year fixed mortgage due to the lower monthly payments, even though it will take twice as long to completely pay off the balance.

Continuing our example from above, a $200,000 mortgage with a 30-year fixed rate of 3.50% will require a payment of $898 while a 15-year loan at 3.25% will require a payment of $1,405 per month. While the difference in monthly payment may be significant, so is the impact on how quickly the loan is paid down. Just five years into these loans, the principal balance remaining on the 15-year loan is nearly $36,000 lower, when compared to the 30-year loan option ($179,394 on the 30-year loan compared to $143,814 on the-15 year).

Sometimes the jump in payment between a 30-year fixed rate to a 15-year is too great, so much so that a borrower may not qualify for the shorter-term loan. Fortunately, there are other options that many may not know about. Mortgage lenders typically also offer fixed-rate terms of 10, 20 and 25 years. Compare these options if you want to shorten the term without dramatically increasing your monthly payment.

ARM to Fixed

Adjustable rate mortgages, or ARMs, offer lower introductory rates and can be attractive for buyers who don’t expect to finance a property for the long haul. Most ARM loans begin with fixed rates, which are in place for a period of time ranging between three to 10 years. After this fixed period, the interest rate can vary on an annual or semi-annual basis.

Refinancing an ARM or a hybrid takes the uncertainty out of future mortgage payments. ARMs can offer lower, “teaser” rates compared to fixed-rate products, but because they can and will change at some point, if fixed rates are low and the home owner intends to own the property for the foreseeable future, it is likely a wise decision to refinance.

When NOT to Refinance

Cashing Out

One of the worst reasons to refinance a mortgage is to pull out cash. Refinancing an existing mortgage requires closing costs, but borrowers typically pay for these with the equity in their home, while simultaneously putting some extra cash in the bank or using it for other purposes.

Refinancing for the sole reason of pulling out cash is a bad, expensive idea. If you are in need of extra cash, a home equity line of credit or second mortgage may be a better option as they are much less expensive overall.

Wasted Interest

Let’s review the $200,000 30-year loan at 3.50% from above. After five years, the amount of interest paid is $33,279. At first glance it seems like a good idea to refinance and lower the monthly payments if possible. By refinancing into another 30-year loan, you’ve lost that $33,279 and extended your loan back to its original loan term, effectively changing your original 30-year loan into a 35-year mortgage!

Important Note: In some instances, particularly those that involve low mortgage interest rates and a long-term outlook, a refinance into a longer-term loan could be an advanced and strategic financial planning decision. This is not intended to be financial advice – however, each situation is unique and you should discuss this option with your advisor in detail.

While the majority of homeowners will consider interest rate as the guiding light towards the appropriateness of a refinance, there are many other considerations worth evaluating. Take your time and consider both the short term and longer-term impacts of your refinance decision.