This
series of articles is about opportunities available to
consumers to save money on an existing mortgage, or on a new
one they plan to take in the near future. This one is about
unexploited refinance opportunities.
Interest rates have been at historically low levels for some time now, some borrowers have refinanced 2 or 3 times, but there are others who so far have allowed the opportunity to pass them by. I am not referring to borrowers who can’t possibly meet today’s standards. They haven’t refinanced because they can’t. My focus is on those who can refinance profitably but don’t for a variety of reasons that don't withstand close scrutiny.
Erroneous Beliefs
The following beliefs that prevent or discourage refinancing have been related to me by borrowers. All are false:
·
Borrowers have to wait some
minimum period after taking a mortgage before they can
refinance.
·
The borrower who refinances
loses the benefit of principal payments already made.
·
The borrower who paid points
to reduce the interest rate on the current mortgage should
wait until such time as the interest savings have at least
covered the cost of the points.
·
The borrower who has had a
mortgage for a long time has to begin the process from
scratch, delaying the period until they are out of debt.
·
It is better for a borrower
who has been making extra payments to continue that
practice, rather than refinance.
Readers
will find explanations of why these notions are wrong at
Valid and Invalid Reasons For Not Refinancing.
Unrealistic Fear of Adjustable Rate Mortgages (ARMs)
There
are borrowers with fixed-rate mortgages (FRMs) who would not
profit from refinancing into another FRM, but who would
profit from refinancing into a lower-rate ARM – but they
don’t because of fear of a possible future ARM rate
increase. In many cases, this fear is not justified because
the borrower can pay off the loan within the initial fixed
rate period on the ARM, which can be 5, 7 or 10 years.
To
execute this strategy, the borrower must have the capacity
to make payments larger than the required payment on the
ARM. There is always a payment large enough to pay off the
loan fully within the initial ARM rate period, the question
being the borrower’s capacity to make that payment. The
previous payment on the FRM might be large enough to do the
trick, or it might not. Even if the borrower can’t pay off
completely within the initial rate period, paying a higher
rate for a few years on a much reduced balance will not come
close to wiping out the interest savings during the
preceding years. For
more on this topic, read
Refinancing
From FRMs Into ARMs.
Failure to Exploit a Profitable Investment Opportunity
Many
mortgage borrowers can’t refinance profitably, or think they
can’t, because their house has declined in value and a
refinance would require the purchase of mortgage insurance
which they don’t have now. However, if they have investment
assets that can be liquidated to pay down their mortgage
balance, the rate of return on investment will be far higher
than the return they are earning on those assets. This is
called “cash-in refinancing” because the borrower is putting
cash into the transaction, as opposed to cash-out
refinancing where the borrower withdraws cash.
Here is an example: John
has a 6% mortgage with 300 months to go and a $100,000
balance, but his house is worth only $100,000, which makes
him ineligible for a refinance. However, if he pays down the
balance to $80,000, he can refinance into a 4.5% loan with
closing costs of 2%. If he stays in the house for 5 years,
the rate of return on his investment, consisting of $20,000
in balance pay-down plus $1600 in closing costs, would be
9.98%. The return is riskless to the borrower.
The return on investment can be calculated using Mortgage Cash-in Refinance Calculator 3f.
Rejected and Gave Up
Some borrowers have not
refinanced because they tried and were rejected, and then
gave up. But not all rejections are created equal --
depending on the reason, some deficiencies are fixable. Here
are a few:
·
You met the underwriting
standards of the Federal agencies (Fannie Mae, Freddie Mac,
FHA) but not those of the particular lender who rejected
you. Some lenders have “overlays” that impose more
restrictive requirements than those of the agencies, and
where this is the case, you might well be approved by going
to another lender.
·
You were rejected because
your credit score was too low for reasons that are quickly
remediable. Examples would be scores lowered by a reporting
mistake, or by credit card balances that are large relative
to the maximums.
·
You were rejected because
your equity in the property was too small based on a faulty
appraisal. A new appraisal obtained through a different
lender could provide a different outcome.
·
You were rejected because
your debt-to-income ratio was too high and you have the
means to reduce it – for example, by borrowing against a
401K in order to pay down other debt.
For
more on this topic, see
Refinance Rejection: Can Anything Be Done?
Next
week: Saving money on a new loan.
