It’s Time to Think About Refinancing Your Mortgage

JAN. 20, 2015

The bond market is a complicated thing, and it is understandable if most people don’t spend a lot of time thinking about it. But even for Americans who don’t want to spend any mental energy on yield curves, convexity and term premia, there is one simple thing to know about the current tumult in the multitrillion dollar market: It’s time to think about refinancing your mortgage.

The average rate on a 30-year fixed-rate mortgage was 3.8 percent at the end of last week. That is down from 4.5 percent as recently as last spring, the lowest since May 2013 and far below the 5 percent-plus rates that prevailed as recently as early 2011.

That raises the possibility that the great American refinancing machine might again chug into motion, leaving Americans with lower monthly payments, more cash in their pockets or both. Homeowners who secured their current mortgage in late 2013 or early 2014, or anytime before mid-2011, may want to at least plug their numbers into an online calculator to see if the potential savings are worthwhile.

Photo

A driver preparing to deliver heating oil to a home in Portland, Me., last week. Falling oil prices have been a boon to consumers in obvious ways, but also in less obvious ones. One result: falling interest rates, which can mean lower housing costs. Credit Robert F. Bukaty/Associated Press

The math can be as simple as you want or as complex; here’s how to think of the decision.

When considering whether to refinance, you are exploiting the fact that you can fully repay a home mortgage whenever you want and take out a new one. If rates rise, you can stick with your old one as long as you continue to own your home; if they fall, you can pay off the old mortgage and get a new one. Heads you win, tails your lender loses. Seldom in life does this dynamic apply, so it is worth exploiting whenever the opportunity arises.

Everyone’s details are different, but if the current rate is half a percentage point below the rate on your mortgage, a refinance is potentially compelling. If it is closer to a gap of a full percentage point, it may be a slam dunk unless you expect to move soon.

But taking out a new mortgage comes with costs, such as origination and appraisal fees — typically in the low four figures. The open question is whether you will enjoy the benefits of lower rates for long enough to cover that upfront cost.

As a hypothetical, a family that took out a $400,000, 30-year fixed-rate mortgage in June 2013 at 4.6 percent could save $187 a month by refinancing $400,000 at a 3.8 percent rate. (If instead of taking cash out they borrowed only the $389,826 they should owe on the mortgage at this point, they would save $234 a month, reflecting both the lower interest rate and a smaller principal.)

Mortgage Rates Have Fallen Sharply

With mortgage rates at their lowest levels since May 2013, homeowners may want to explore refinancing options.

Average rate on 30-year, fixed-rate mortgage

%

5.0

4.5

4.0

3.5

3.0

3.8%

2011

2012

2013

2014

2015

Grayed-in areas indicate times when prevailing rates were at least half a percentage point higher than current rates; those with mortgages issued during those times may want to look into refinancing.

Source: Bankrate.com, via Bloomberg

Before taking the plunge, though, our family has to decide how long it expects to stay in the home. If transaction fees add up to $4,000, for example, the family needs to stay in the home for at least 21 more months (if borrowing $400,000; 17 months if borrowing $389,826) to justify the transaction (or a bit longer if you also try to account for the tax savings they are not receiving because they are paying less to the bank in mortgage interest).

Or here’s another intriguing possibility. Let’s say our family has seen its income rise since originally taking out the home loan in mid-2013. The interest rate on a 15-year fixed-rate mortgage is now a mere 2.9 percent. An option would be to refinance the $389,825 currently owed into a 15-year mortgage. That would increase the monthly payment by $623 a month — but would result in paying the home loan off entirely in 2030, not 2043 as the family was previously on track to do.

As with all major financial decisions, the details of each family’s situation can add all kinds of complexity that are worth gaming out and analyzing carefully. But for the economy as a whole, this latest shift in rates has a particular silver lining.

In years past, mortgage rates have dipped when it looked as if the United States economy could be falling back toward recession, and the Federal Reserve intervened with easier money to try to stop that from happening. This time, the economy is looking relatively strong and the Fed is making plans to raise interest rates.

This drop in mortgage rates is being driven by a combination of plummeting oil prices, which are reducing investors’ expectations for inflation in the years ahead, and a tumultuous global economic environment, which is leading investors worldwide to plow money into safe American assets. That includes the bonds packaged by the government-sponsored mortgage finance giants Fannie Mae and Freddie Mac, which in turn fund most of the nation’s consumer mortgages.

In other words, global investors are so desperate for a safe place to park cash and so confident that inflation is nowhere to be found that they are flinging money at United States homeowners. Americans now paying significantly above-market rates on their home loan might at least do them the favor of picking it up.

www.nytimes.com
by Neil Irwin