Citizens of Denver considering a refinance, I am currently reading your mind. You’ve heard that mortgage rates are dropping and you’re wondering if you should be considering yet another refinance. The answer to this question is, wait for it, ‘it depends’.
Never fear, your friendly neighborhood banker is here not to advise, persuade or cajole, but to inform. I’m going to give you the tools you need to decide for yourself if a refinance makes sense and if so, how to reduce the risk of rate timing and exposure to costs.
So, SHOULD YOU REFINANCE? First, the good news! Refinancing is a purely number based decision! Yay! That means that emotion and opinion really don’t matter much so you can toss those both right out the door. Determining whether or not you should refinance is based on the outcome of a very simple equation: Closing Costs / Monthly Savings. If the number is less than that number of months you plan to stay in your home, you should probably think about refinancing. Most of the time, you’re going to be better off by asking your banker (me of course) to pay all of your closing costs. It will mean you have a slightly higher rate, but if you check the chart below, you’ll find it’s worth it. Those who plan to stay in their homes a very long time may still benefit from paying costs, so you’ll need to run the numbers to see what fits you best.
This is just a hypothetical and doesn’t necessarily reflect the market’s current conditions, but it is a reasonable comparison. The following assumes two borrowers, Jack and Jill. Jill decides to refinance her house having the banker pay for closing costs, Jack opts to pay all costs to get the lower rate. Take a look at how they both come out in the end.
|Closing Costs||ZIP, ZERO, ZILCH||
|New Monthly Payment||1,393.39||
|Number of months for Savings to pay for costs||Savings begin right away||36.6 moths for savings to pay for closing costs|
If you take the formula I gave you above (closing costs/monthly savings) you’ll get what bankers call the “recovery curve”. This describes the amount of time it will take for your savings to pay for your closing costs. You can tell from this chart that over the first 36 months, Jill has done much better than Jack. She saves 82.87 per month which is worth almost 3,000 dollars in her pocket during that time period. Jack on the other hand will take 36 months just to pay for the refinance and only after that will he begin to save money. If Jack is planning to live in the home for 30 years, paying for the lower rate was worth it, but it’s going to take almost 7 years for him to outrun what Jill is saving. That is longer than most Americans will stay in their homes.
Once you’ve decided whether or not to refinance, reading your mind tells me that your next big question is WHEN SHOULD I LOCK?
The answer to this question is best given in an old Wall street adage ‘Bears and Bulls both go to market but Pigs just go to slaughter‘. Basically, what that means is that the best time to lock is usually as soon as the numbers make sense. There are very few environments where a good banker would recommend that you float (avoid locking while waiting for rates to improve). It does happen, but it’s rare. Don’t let your banker gamble with your mortgage debt, it’s too huge a number to be wrong about. The mortgage market tends to stretch gradually lower like a rubber band being tightened. When it hits whatever level of resistance it picks though, it tends to rise rapidly. This process has lulled many a borrower to their mortgage death because they thought rates would go lower and lower and were holding out for a better deal only to find that the better deal was yesterday, or 10 minutes ago. It’s a shame. In a downward market like this one ‘lock em if you got em’ is a better philosophy. Keep in mind, if rates drop another .125% you only lost about 10-20 bucks per month, no big deal. If you missed the drop all together, the opportunity costs could be huge.
As always, if you have some questions about how to apply these principles to your situation, give me a call, we’ll talk it over and make sure you have the information you need to make a good decision.
Until then, I wish you Better Banking!