Is Now the Time to Refinance Your Mortgage?
In recent months, the weakening job market, the housing slump and the subprime mortgage crisis have combined to prompt the Federal Open Market Committee (FOMC) to make aggressive cuts to its target for the federal funds rate, the rate that banks charge when they lend money to other banks. The FOMC has slashed rates by a total of 225 basis points since September 2007, including 125 basis points in January alone. Overall, the FOMC intends the rate cuts to help promote moderate growth and mitigate risks to the economy. However, a lower federal funds rate can have a significant impact closer to home—on your mortgage.
If you have an adjustable-rate mortgage (ARM) that’s tied to Treasury rates, you’ve likely already seen a reduction in your monthly payment. However, if your ARM is a “jumbo loan” tied to an index that is slower to respond to rate cuts, it will take longer for a potential reduction to surface. Because rates on fixed-rate mortgages and home equity lines of credit (HELOCs) almost always follow the prime rate (which generally moves in lockstep with the federal funds rate) those interest rates already have dropped, leading to a flurry of refinancing activity. According to the Mortgage Bankers Association’s “Weekly Mortgage Applications Survey” for the week ending February 15, 2008, the refinance share of mortgage activity represented 61.7 percent of total applications.
So, is now a good time to refinance your fixed-rate mortgage or HELOC? Although the old 2% rule dictates that interest rates should be two percentage points below your current rate before it’s advantageous to refinance, remember that mortgage companies often waive routine refinancing charges such as application, appraisal and legal fees. Accordingly, rather than basing your decision on a comparison of two interest rates, the answer to your refinance question depends on the relationship between your current mortgage payment, your potential new monthly payment, the closing costs associated with refinancing, and how long you expect to stay in your current home.
Begin your analysis this way: subtract your projected new payment from your current payment to determine your potential monthly savings. Then divide your total closing costs (exclusive of funds to be held in escrow) by your monthly savings. If you plan to live in your home for more months than that number, refinancing will put you ahead. Particularly if you find a no points/no closing costs deal, even a small rate cut sometimes can pay off. If you plan on living in your home for a long time, be sure to work your calculations with and without points.
The Internet offers a number of helpful resources. You’ll find plenty of information, including current rates and mortgage calculators at Mortgage101 and the Mortgage Bankers Association’s Home Loan Learning Center. Another good resource is a seven-page report published by the CMPS Institute titled “How to Safely Manage Home Equity.”
Keep in mind that, in addition to lowering your fixed-rate, there are other reasons you might consider refinancing. For example, you might want to trade an ARM that has high or no limits on interest rate increases for the security of a fixed-rate loan. You also might consider refinancing to convert to a loan with a shorter term. In that case, although you’ll have to manage a higher monthly payment, you’ll build equity faster and pay less in total interest over the life of the loan. If you can’t afford the payments on a 15-year mortgage, ask your mortgage company to customize your new loan’s term to match the years left on your old loan. That is, if you are five years into a 30-year mortgage, ask for a 25-year loan. Of course, another way to build equity faster without committing to the higher payments of a 15-year mortgage is simply to make an extra mortgage payment in the months you can afford to do so.
Before mortgage shopping, check to make sure your existing mortgage does not have any pre-pay penalties. And, once you decide on an experienced and stable mortgage lender, make sure to get all your refinancing terms in writing, including the all-important interest rates and closing costs as well as the fine print details relating to potential pre-pay penalties that might be assessed should you decide to refinance again in the future.
The bottom line: as experts expect continued interest rates cuts, mortgages now need to be managed – and we’re always happy to help and be a resource for you.
Other References of Interest:
Brett Arends, “The Fed and You: Don’t Wait to Refinance,” The Wall Street Journal, January 30, 2008.