Should I Refinance My Home During the Pandemic? CWM Answers Common Questions
…and homeowners are more likely to secure a favorable interest rate now compared to this time last year.
You may be asking if now is still the right time to refinance. As I touched on in our July Thirdly series, "Defense Takes the Field,"1 there are a few key questions and variables that we encourage homeowners to factor into their decision-making.
How does the size of my loan affect my interest rate?
Not all loans are created equal. While the 30-year fixed mortgage rate has reached historic lows (at or below 3%), beneath the umbrella of fixed mortgages there exist rates for conforming loans – those less than $510,000 in the state of Washington – and for high balance and jumbo loans, or mortgages larger than that amount. Typically there is little to no noticeable difference between the fixed conforming rate and the fixed high balance and jumbo rates, but currently we are seeing high balance and jumbo rates at about 0.45% higher than conforming (as of when we discussed this in our August 2020 Thirdly), which reveals distinctions in the ways the two rates are calculated. I should point out that back in July the difference between a conforming 30-year fixed and a jumbo 30-year fixed mortgage was around 0.94%. Since then the spread has been cut in half, with a 0.375% difference between the two rates.
The conforming rate is backed by The Federal National Mortgage Association (Fannie Mae) and The Federal Home Loan Mortgage Corporation (Freddie Mac), which, as government entities, don’t consider any risk pricing when calculating their rates. On the other hand, the high balance and jumbo rates reflect private market forces, and both price in the risk of high unemployment, the spread of COVID-19 and other potential risky events on the horizon.
How does my amortization schedule factor in?
To provide a simplified overview of amortization, in a 30-year fixed mortgage, the monthly payment remains the same for 30 years, but early on your payments primarily go toward the interest, leaving the principal relatively unchanged. It’s not until you’re 18 ½ years into the amortization schedule that you reach 50/50: equal principal and equal interest in each payment (assuming you’ve made no extra principal payments). After that point, the scale tips, so that more of every subsequent payment goes toward principal instead of interest, which is where you really begin to chip away at the balance.
If you’re already nearing or beyond that halfway mark in the amortization schedule, refinancing may not be the right decision for you, depending on your other circumstances.
How does a lower monthly payment factor in?
Securing a lower interest rate to help reduce monthly mortgage payments is appealing to many borrowers. However, we also know there are fees and expenses involved in taking out a new loan. So how do we know when the monthly savings will be worth the overall cost of borrowing?
In order to better visualize this, let’s look at the actual mortgage of a client, whom we’ll call Samantha. Samantha currently has a monthly payment of $2,431.98.
By refinancing, she has an opportunity to reduce her monthly payment by as much as $344.36 through points – paying more up front in order to “buy down” and lower the interest rate over the life of the loan. Outlined below are three refinancing strategies available to Samantha—Strategy 1: Most Points; Strategy 2: Some Points; and Strategy 3: No Points.
At CWM, we rarely recommend a client pay points, although in some cases it may make sense for a homeowner to spend the extra money today to realize greater savings from living in the house for the long term. Everyone’s situation is unique, which is why we advise working with your financial planning team to develop a customized strategy.
In Samantha’s case, the “no points” strategy makes the most sense and will still net her a lower rate that reduces her monthly payments by $314.09.
How much does it cost to refinance, and when will I break even?
While Samantha’s lower monthly payments are appealing, it is also important to ensure those savings are greater than the expenses involved in the refinance process. To understand that, we start by looking at the cost-to-borrow statement.
Samantha is shocked to see her fees for underwriting, escrow, title insurance, tax and insurance reserves and other processing and recording activities total $7,443.57.
However, three key elements of the cost-to-borrow statement – tax reserves, hazard insurance reserves, and premiums — are pre-paid costs associated with the old loan, meaning we can exclude them from the true cost.
Now, we can see the true cost of the refinance is $2,708.32. We’ll take this number, divide it by our $314.09 in monthly savings, and arrive at Samantha’s break-even number of 8.62, meaning the money she saves on a monthly basis will offset the one-time true costs in 8.62 months.
True cost of refinance = Borrower paid amount – taxes reserves – hazard insurance reserves – hazard insurance premium
# of months to break even = True cost of refinancing / savings on monthly payments
One thing missing from this calculation is the appraisal, which is not included because it varies depending on whom you work with, and neither the broker nor the borrower can choose the appraiser. Appraisal costs generally vary from $650 - $750 currently in Washington state. Once you know those numbers, you can add that to the cost-to-borrow expenses and divide by monthly savings to get the break-even time – which is likely to vary between eight and 10 months.
Samantha, who plans to continue living in her house for much longer than her break-even number of 8.62 months, can consider refinancing a sensible step.
Should I refinance now, or wait until later?
For several reasons, it is smart to explore and make a decision about refinancing quickly.
Importantly, if you are worried about your job security, time is of the essence. Since banks determine loans based on previous years of tax returns and employment history, losing your job and being unable to show proof of income can place severe limitations on how much you can borrow, even if you’ll be able to get another job again soon.
Another element to consider is the potential for changing interest rates. Interest rates are currently dropping from 4% to 3%, but many experts suggest they may not stay this low for long.
Before you decide, consider reaching out to a financial advisor. The CWM team is here to offer support in developing an individualized strategy. Give us a call at (425) 778-6160 or request an appointment today to discuss your options in planning a home refinance, or with any other questions you may have.
1 The password to view the presentation is available under the Announcements section of your CWM Client Portal.
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