Since my last blog, a lot has happened. The spread of Covid-19, otherwise known as the Coronavirus, has wreaked havoc on the world, the economy, and especially the real estate market. Prior to all of us getting locked down with a stay-at-home order, I had a follow up to my most recent post "Are Multifamily Properties the Saving Grace for First Time Homebuyers?" already planned. However, with interest rates falling off a cliff, I have been asked well over 200 times in the last month "Should I refinance my mortgage?" While I'm not a mortgage broker, one thing I'm not afraid to do is share my opinion. So, I pivoted and decided to dig into the important decision of refinancing.
Last week mortgage refinancing applications accounted for 76.2% of all mortgage applications and were192% higher than the same week in 2019 so it's important to understand why refinancing has become such a hot topic right now. Really, there are multiple factors that have all converged at once to form the perfect storm for refinancing. The first factor to consider is the current interest rate. The 30-year fixed mortgage rate averaged 3.45% last week and Freddie Mac is predicting an average across all of 2020 to be 3.3%. A significant drop from 2019's average of 3.9%.
Another factor driving refinancing is unemployment. The stay-at-home orders that most states are under have led to more than 21 million unemployment claims over the last four weeks, meaning more than 10% of the U.S. workforce is now without a consistent paycheck.
Finally, while many states have deemed real estate as essential, the market has largely ground to a halt. Many sellers are holding off listing their properties until demand increases or are pulling them off the market due to buyers, uncertain about their employment future, holding off or just not physically being able to see the property.
So that's why people are moving in mass to refinance, but we haven't answered if they should be. In my opinion, in order to determine if you should refinance, it is imperative that you have a complete and undeniable understanding why you want to refinance. If you're refinancing for the simple need or desire to reduce your monthly payments and no other reason, then by all means go for it. But make sure you understand these important facts before taking the leap.
The benefits are obvious, a lower principle amount and a lower interest rate spread back out over 30years will provide a significant savings in your monthly payment. A benefit that can range anywhere from $60 - $100 per $100,000 mortgaged. Another benefit is most refinances will require a new appraisal of your home. If it's been a few years since your original purchase, you're sure to have seen some appreciation in value. The benefit here is that between appreciation and principle reduction, those who purchased their home with less than a 20% down payment should be able to significantly reduce their PMI and maybe completely eliminate it from the refinance loan. An additional savings to your monthly payment.
But with every coin there is, of course, a flip side. When you refinance, you reset the clock on your amortization schedule. For those not familiar with what this is, the amortization schedule breaks out how much of your payment goes towards interest and how much goes towards principle from payment1 to payment 360 of your 30-year mortgage. Amortization tables are significantly weighted toward interest at the beginning of the loan and slowly reduces to where your final payments are almost all comprised of principle repayment. To understand the negative impact of this reset, let's look at a hypothetical scenario. Take a homeowner who has been in their home for five years and paying a $2,000/month mortgage. After five years, about 40% on average of their monthly payment is being applied to paying down their principal. In this scenario, that's $800, with the remaining $1,200 going in the bank's pocket as interest. This same homeowner refinances and reduces their monthly payment to$1,500/month but resets the amortization table. At the beginning of a loan, 95% of the payment can be going towards interest. In this case, that means $1,425 a month now goes towards interest, leaving only$75 to apply towards principal. You as the homeowner have now reduced how quickly you are paying down the principal each month by almost 91%. This reduces how quickly you build equity in your property. Yet the bank has increased their profitability by almost 19%. Therefore, you've got to ask yourself, who's really winning by refinancing, you or the bank?
Finally, we haven't even talked about closing costs or credit scores. Just like when you originated your existing mortgage, the bank is going to charge you on average between 2% and 5% of the loan amount to initiate the new loan. On the low end, that's $10,000 for a $500,000 mortgage. If we continue the hypothetical from above, you would need 20 months at the $500/month savings to make up those closing costs. You can, of course, role the closing costs into the loan, but that will just offset some of the savings you were hoping to achieve. Now you need to ask yourself, would you rather that $500 be going in your pocket or the banks? Also, remember that you go through almost the same underwriting process as in refinancing as you did to originate the loan. This means another hard hit on your credit which could make it more difficult to secure other future financing like a car loan, or at a minimum jeopardize your opportunity to get the lowest rates for other forms of financing down the road.
If your sole purpose is to simply reduce your monthly payment and you don't care about anything else, then refinancing is probably for you. But if maximizing your home equity is important to you or you're planning on selling your home in the next four to five years, it would be in your best interests to speak to a mortgage broker, a financial advisor, an accountant, or all three to understand the pros and cons.
At the end of the day, the real winner in refinancing is the bank. As a homeowner considering refinancing, it is imperative that you understand how all the mechanisms of a mortgage work so you can make a sound financial decision. The answer may surprise you.
Todd Wilkinson is the Founder and Owner of FonHome Realty. FonHome is a customer-centric brokerage where our clients are in control and our experienced agents are respected for providing the positive and exciting experience the real estate transaction should be. Todd is an accomplished real estate investor with an undergraduate degree in Financial Economics and a Masters’s degree in Business Administration. Todd has held senior management and executive-level positions with the world’s two largest retailers and a successful startup venture. Todd has served terms on the University of Arkansas Advisory Board and is actively involved with the St. Theresa School in Kenilworth. Todd opened his own brokerage after feeling underserved in his personal experiences with real estate transactions and wanted a firm whose mission was on serving the fiduciary responsibilities guaranteed to the Buyer and Seller. Contact Todd today for a free Comparable Market Analysis for your home or for advice on beginning your search for a new home at www.fonhomerealty.com.
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