Refinancing Right Now Might Make Sense. Here’s Why.
Refinance before the new fee hits on October 1st and have the Federal Reserve help pay your mortgage for you. The Federal Housing Finance Agency (FHFA) is imposing a 0.5% fee for all mortgage refinancing on October 1, 2020, so on a $400,000 loan, you will pay an extra $2,000 in closing costs. When you take this into account, rates may never be this low again.
You may have heard that, as one of the few upsides of the COVID-19 pandemic, conforming mortgages are at all-time lows; so low that even though my family refinanced less than a year ago, it is worth us refinancing again – and that may well be the case for you, too. (Note: We have a conforming loan. Jumbo rates are not necessarily so competitive.) Our current 15-year loan was only charging 3.125% but we are refinancing to a 30-year loan and still getting a lower rate. We wanted to pay off our mortgage more quickly, but it was too hard to pass up 2.375% on a 30- year mortgage. At this rate, the government will likely be helping to pay off our mortgage for us. I’ll explain how this works later.
Normally, I advocate only doing a “cost-free” refi. This means that you should only refinance if it will cost you nothing out of pocket and nothing gets added to your loan, i.e. the refinance is COMPLETELY FREE with no hidden charges. This means that if you choose to sell or refinance in a year or two, as we just did, you are not out of pocket and your loan has not increased.
However, if mortgage rates have finally bottomed, it may make sense to pay fees to get an even lower rate, particularly if you intend to stay in your house long-term. So, since my family insists we must never sell our home, I am willing to take the bet that mortgage rates will never get lower. It turns out that, if I pay closing costs and around 0.4% points, I will make up these costs in three to five years with a lower monthly payment. For me, 2.375% was the sweet spot. Anything lower was not cost-effective because it took too many years to make up the difference.
At WellAcre Wealth, we are happy to help you find your sweet spot, so feel free to reach out to us. (A word of caution to those with low loan balances – say under$250,000 – and an already competitive interest rate: further savings may not make up for the fixed closing costs. Do the calculations before proceeding.)
Will rates get lower? If they do, it will have to be enough to make up for the added 0.5% FHFA fee. Could this happen? Yes. There has been a huge demand for mortgage refinancing over the last few months and mortgage companies are so overwhelmed they do not have to be as competitive. This means mortgage rates have not been quite as low as would normally be expected compared to other interest rates, given the Federal Reserve has set short-term interest rates at zero. So, if other rates stay close to zero, mortgage companies might reduce rates further as they have to compete for more.
Could the Federal Reserve reduce interest rates below zero? This sounds crazy, but it is possible. Currently, interest rates in Japan and Germany are negative. That means you get paid to borrow money. According to the Guardian newspaper last year, a Danish bank was offering negative 0.5% mortgages: they were paying people to borrow to buy houses.
However, although this could happen in the USA, the Federal Reserve has stated it will not allow rates to go below zero. Indeed, the Federal Reserve changed its guidance last month and is now doing its best to stoke inflation above 2%. This brings us to the other reasons you should refinance now.
If the Federal Reserve is successful in stoking inflation, that will gradually lead to higher mortgage rates. Indeed, the August inflation figures were encouraging, as the month over month increase was the highest since 1991 (US Bureau of Labor Statistics).
Finally, if the Federal Reserve manages to increase inflation to, say, average 2.5% over the next 30 years, and you get a mortgage for 2.375%, then you too are being paid to buy your house since, after inflation, you are getting a negative real interest rate.
Add in the effects of taxes and the negative real interest rate is even greater, (for qualifying taxpayers). For example, if your tax bracket is 24% Federal Tax and 9% California, then on a 2.35% loan you are only paying 1.59% interest after tax. The Federal Reserve hopes this will be below the rate of inflation over the next 30 years, so they intend to help pay your mortgage for you.
Just one word of caution: this advice works great for those who already own houses and intend to stay in them. These same dynamics might make it a bad time to buy. Ultra-low mortgage rates are pushing real estate prices up to possibly unsustainable levels and prices could decline over the next few years. More on that later.
Once again, please reach out to us if you would like us to help analyze your mortgage broker’s figures to ensure there are no hidden costs, and to help you make an educated choice.
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