Home Refinancing: Golden Goose or Hidden Pitfall?

In the midst of 2020 market volatility, economic crisis and coronavirus fears mortgage rates just dropped to the lowest in recorded history, – since Freddie Mac began tracking rates 50 years ago!¹  According to Freddie Mac, the average 30-year fixed rate mortgage dropped to 2.88% during the first week in August, and the 15-year average fixed rate mortgage dropped to 2.44%.² While home mortgage rates were already quite low by historical standards, this new wave of even lower interest rates could potentially provide you with a great opportunity to refinance your current home mortgage.

What should you consider before taking the refinancing plunge with the cheaper mortgage “golden goose”?

How Much Money Could You Save?

The substantial decrease in interest rates may provide a chance to reduce your monthly payment, even if you recently obtained your home mortgage.

For example, let’s say you took out a $750,000 home loan, and your current 30-year mortgage rate is 4%. By refinancing to another 30-year loan and reducing your rate down to 3%, you could potentially save over $400 per month in this simple example. Your exact monthly savings could be higher or lower, depending on other mortgage terms, as determined by your bank.

Hidden Potential Pitfalls?

Problem of “resetting” your loan for a longer term

It is important to consider the total interest cost of your current loan now and until maturity against the interest cost of resetting your loan with the new lower rate.  Let’s say you have a current mortgage with 23 years left (you have paid interest for 7 years) and a new mortgage will be a 30-year term.   With the refinance, you will effectively “reset” back to a 30-year term.

To understand the cost of the reset – you or someone on your Modera team can calculate how much in interest you will pay over the next 30 years on your new loan, relative to the amount of interest you will pay on the remaining mortgage. It’s possible that the total interest cost of the existing mortgage would be less than the refi mortgage, even with the lower interest rate on the refi mortgage.

Refinancing costs

Making an apples-to-apples cost comparison of refinancing options can be difficult. This is because banks tend to layer on differing fees, as well as loan requirements.  Fees include appraisal costs, loan origination charges, points, title fees and more.

Use the Annual Percentage Rate (“APR”): The APR is required by the Federal Truth in Lending Act to help consumers discern the true cost of each loan.  The APR includes not only the interest expense on the loan but also most of the fees and other costs involved in procuring the loan.³

Consider the cost of different loan terms: Some lenders will require you to include the payment of insurance and property taxes in your mortgage bill (“escrowing”) and some will not.  Remember that banks will require this frequently to assure these costs get paid, and their collateral is protected, but they also make money keeping these funds. You may be better served on your end by saving these funds in an interest-bearing account and paying these costs only when due.

Potential Aggravation and Time Investment

The mortgage refinancing process takes time, and you will be required to provide quite a lot of information to the lender. The process of qualifying for a mortgage has become significantly more time consuming since government requirements were put in place after the 2008/2009 mortgage crisis. Your Modera wealth manager can help you gather needed information for the bank, but the process can still be time consuming.

Other Mortgage Refinance Strategies and Things to Consider

How Long Will You Stay in Your Home?

Typically, it makes the most sense to refinance when you plan to stay in your current home for many years. However, it may make less sense to refinance your home loan if you think you will be moving within the next 3-5 years. Consider those mortgage refinancing costs (above), and how long it will take to “break even” on the cost of refinancing. We generally like to see a “break-even” calculation (out-of-pocket costs to refi relative to the monthly savings) of one-year or less.

Is it Time to Fix Your Current Variable-Rate Loan?

If you currently have a home mortgage with a variable-rate loan, your monthly mortgage payments can change with movements in interest rates. Now may be a great time to secure a low fixed-rate mortgage to avoid future cash flow volatility and have 100% confidence about what your mortgage payment will be every month.

Does it Make Sense to Take Cash Out of Your Home?

A home refinance can provide a great opportunity to tap into the equity in your home, particularly if your house has recently appreciated in value. With a “cash-out refinancing”, you take out a new mortgage at the new lower interest rate and request a loan amount that is larger than what you owe on your home. The difference becomes a low-interest loan that you can then repurpose toward other financial needs, such as college education, paying off more expensive debt, a car purchase or even for investment purposes.

Will the Interest on Your New Loan be Tax Deductible?

Home mortgage interest deductibility has long been a benefit of home mortgages; however recent changes to tax laws have greatly affected who may benefit going forward. According to the new IRS rules, you can only deduct home mortgage interest on the first $750,000 of mortgage debt (or on the first $1 million if the mortgage was originated before December 16, 2017)⁴; but this is the case only if you qualify to itemize all of your income tax deductions during the tax year. For many taxpayers, meeting the requirement to itemize deductions is more difficult than it used to be due to the new higher standard deduction amount. You can always consult your Modera wealth manager to help you determine your eligibility to itemize your tax deductions and take advantage of potential mortgage interest deductions.

Does it Make Sense to Talk to Your Current Bank?

Your current mortgage lender may provide the most attractive and convenient option to refinance your home loan. This is because your bank already has your payment history and will be more comfortable making a new loan to you (translation, less time and paperwork may be involved).

…But Shop Around Too (and Read the Fine Print)

Of course, it never hurts to shop around for a better mortgage rate. Keep in mind that you should always compare more than just the mortgage rates between lenders and be sure to consider the “APR” and other possible hidden mortgage costs (see above). Ask your lender to outline all mortgage costs that you will be expected to pay at closing so that there are no surprises.

Today’s historically low interest rates could potentially provide a financial opportunity and even be your “golden goose” in a very tough 2020. Consider your Modera wealth manager to be your partner in the refinancing process.  We can help you locate and assess lenders in the marketplace.  We can also help determine if the potential monthly savings would make refinancing worth it for your individual situation.  Finally, we can provide some of the needed information about your financial situation to your lender.

We look forward to helping those of you interested in refinancing!