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Revisiting Mortgage Refinancing

Clients have a golden opportunity to save money and/or raise needed cash.

Once you’re done addressing the latest stock market volatility with your clients, you may want to bring up an instant and virtually guaranteed moneymaking idea that has been created by the current economic circumstances: refinancing their mortgages.

It’s probably not as exciting as monitoring the gyrations of their portfolio, but there has likely never been a better time to do so, and there may never be as good of an opportunity again.

Why now?

Start with the near-record-low interest rates. According to Freddie Mac, the current rate on the 30-year mortgage (3.36%) has only (and barely) been surpassed in late 2012 and early 2013. The 15-year rate has even dropped below 3.00%, down to 2.77%.

But due to high demand for housing in most markets, valuations have likely never been higher. The Federal Reserve Bank of St. Louis says the average sales price of a home in the U.S. in the fourth quarter of 2019 was $382,300, just a shade off of the all-time high of $399,700 in the fourth quarter of 2017.

A lower interest rate and surging home values certainly make lenders more friendly to would-be borrowers. And your clients’ credit situation is likely to encourage the banks’ enthusiasm—the average FICO score hit a record high of 703 in 2019.

Last but certainly not least, clients on the cusp of retirement may want to get a new mortgage now, while they still have a paycheck that can help get an approval for the loan. Once they’re done working and have no regular earned income, it could be trickier to get the best rate on a traditional mortgage.

Estimating the payoff

A lower interest rate will mean a lower monthly mortgage payment for your clients. But that’s not the only factor they should consider when deciding whether to refinance.

They should also account for the closing costs that will be charged by the lender (and others). The expenses could include an appraisal, title fees, flood certification, plus points if the clients are “buying down” the interest rate (a step that’s probably not necessary in today’s low-rate environment).

Once those costs are known, the clients can weigh them against the lower monthly payment to see if financing is worthwhile.

Let’s say your clients owe $300,000 on a 4% mortgage that has 15 years left. They are looking to refinance the amount owed to a new 15-year mortgage at 2.75%.

Their current monthly payments are $2,219, and the payments on the new mortgage would be $2,036—a savings of $183 per month.

The website Value Penguin says that the average cost of refinancing a mortgage is currently $4,535. If that’s what your clients would have to pay for a new mortgage, it would take about 25 months before the lower payment exceeded the refinancing cost.

That’s fine if the clients plan on staying in the house for at least that long. But if they are thinking about selling the house, paying off the mortgage or possibly refinancing again in the near future, they may be better sticking with their current loan.

15- or 30-year?

That tantalizingly low number for the 15-year mortgage should certainly tempt homeowners into taking the lower rate, shorter term (and higher minimum payment) that the 15-year loan offers.

But clients may want to instead get a 30-year loan and make the minimum payment that would have been required if they had taken out the 15-year mortgage.

They will still pay off the 30-year loan in about 15 years and nine months. But in the meantime, if interest rates rise, or the clients’ circumstances necessitate it, the clients can reduce their monthly payment back down to the minimum required by their 30-year mortgage.

Just refinance, or get more cash?

It’s probably smarter (and more exciting) for clients to just refinance the amount currently owed on the mortgage.

But some borrowers may be better off asking for whatever extra cash they can get (before exceeding the 80% loan-to-value ratio, which could trigger the need for expensive private mortgage insurance).

The extra proceeds could (and should) be used to pay off higher-interest-rate debt or perhaps cover a planned home remodeling project.

If the clients are a little too spendy and self-aware of that fact, they may still be better off just refinancing enough to pay off the original loan and not letting the extra money run through their hands.

Better yet, calculate the difference between their old monthly mortgage payment and the new one, and channel that amount into savings, instead of spending.

On the other hand ...

Maybe paying off the current mortgage might be better than keeping the current debt, or taking on more. Especially if the clients can pay it off in full without tapping tax-sheltered retirement accounts and annuities, or selling assets that would trigger a capital gains tax.

Not having a mortgage payment every month means the clients’ regular expenditures can be cut substantially, and if they were tapping their IRAs to cover those expenses, maybe their tax bill will go down as well.  

Some clients might balk at paying off the mortgage by saying “what about the tax break I’m getting on my mortgage interest?”

But homeowners can only deduct mortgage interest if they itemize, instead of taking the standard deduction. And since the standard deduction for 2020 is $24,800 for married couples filing jointly ($12,400 for single filers), many clients might not have enough itemizable deductions to beat the standard amount, even when they figure in their mortgage interest.

However, if they do decide to pay the mortgage off, have the clients establish a home equity line of credit (HELOC) for as much as the lender will allow. Then they can tap the HELOC without the application and appraisal hassle if they need some quick cash for the next personal or financial emergency.

Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster). 

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