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The Federal Reserve Just Slashed Rates to near 0%, Should I Refinance My Mortgage?

by Phil Tull | April 28, 2020 | Retirement Planning

Seems like a no brainer, right? Well, not necessarily. When the Fed cuts rates, it does not perfectly correspond with mortgage rates. Let’s dive into the “why” behind mortgage rate movements and the current climate.

Rate cuts have an impact, but they do not always directly relate to your 15- or 30-year fixed mortgage rate. The Federal Reserve drives lower-cost borrowing and bank overnight rates, but that doesn’t necessarily meet the need for the buyers of Mortgage Backed Securities (MBS). Mortgage rates tend to track more in-line with the 10-year treasuries, though these are not perfectly correlated and have shown significant divergence in recent weeks. During February and March of 2020, we have seen mortgage rates hit lows while also showing historically unprecedented volatility throughout March. The $2 trillion CARES-ACT stimulus package will likely include MBS purchasing by the Fed and could drive the rates lower once again, though there is no certainty. The sharp rise in mortgage loans and refinancing across the nation has led to an artificial increase in rates caused by the mobility of lenders to manage the spike in demand.

Now that we have a better understanding of the contributing factors, let’s take a look at personal applications.

Below are a few areas to assess when considering if you should refinance your mortgage:

  • Rate Difference
    • Would the new rate be low enough that you would be able to recover the closing costs during the time you reside in the home?
      • Here’s a general rule of thumb for when to consider refinancing: a rate cut of 0.5% or more generally can be recovered in five years or less.
    • Be sure to shop around and compare rates of lenders.
  • Closing Costs
    • How long will it take to recover the closing costs?
    • If you do not want to use the cash you have on hand, your lender may allow you to roll the closing cost into your mortgage loan balance. Again, reference the rule of thumb above.
  • How long do you plan to live in the home?
    • Remember, refinancing will restart your timeline and amortization schedule back to year one. This may have an impact on your retirement planning strategy.
    • Consider a 15-year mortgage if you are further into your loan. A steep rate reduction may make a 15-year loan’s monthly payment fit into your budget.
    • If the flexibility in your monthly amount is attractive to you, you may want to consider the 30-year fixed rate mortgage. This would allow you the ability to make lesser payments during times of hardship and/or larger payments when cashflow allows.
  • Other
    • Mortgage insurance
      • Has your home gone up in value? If so, the appraisal value of your home may eliminate the need for mortgage insurance, if the loan-to-value ratio is less than or equal to 80%.
    • Cash out
      • If needed, you may also be able to refinance for the original loan amount, while also converting your home equity into cash.
      • Although we advise that a cash out not be your main incentive to refinance, circumstances may arise where cash in hand is necessary for an unplanned life event.

Example – Refinancing for a 0.5 percent lower rate:

Loan balance $300,000
Current interest rate 4.00%
New interest rate 3.50% (-0.5%)
Monthly savings $125
Closing costs $6,000 (2.0%)
Time to break even 4 years
Worth it? Yes, if you stay longer than 4 years

Refinancing is a great opportunity and can provide significant financial benefit which could be excellent news for your retirement planning. However, it should not be considered a “good for all” opportunity. It is often easy to fall into the herd mentality. We encourage our clients to be thorough in their decision as to whether refinancing is the right decision. We can help you asses all the aspects involved so you can have a more objective insight on whether a refinance is the best decision for you and your family.