How Refinancing Impacts Your Investment Portfolio
Shopping for a mortgage is no one's idea of fun, but doing it right can save you thousands of dollars over the years -- and perhaps tens of thousands. This might be a good time to take out a new mortgage or refinance an old one, as many experts expect rates to rise.
Of course, they might not -- or not so soon. In December, the Federal Reserve made headlines by increasing its short-term federal funds rate for the first time in nearly 10 years. But it didn't raise rates again when it met at the end of January, and now it looks like the sluggish world economy may help keep U.S. mortgage rates down for some time.
While the Fed controls some very short-term rates, long-term rates that guide fixed-rate mortgages are governed by investors' views about future conditions.
"We know [mortgage] rates cannot go much lower, and many in the financial community have been saying that rates are going to rise for several years, but we've been very wrong on the timing," says Geoffrey M. Tomes, wealth advisor with David A. Noyes & Co., a wealth-management company in Chicago.
"I think rates will rise long term, but the short term is a relative unknown," he adds. "A prudent decision would be to plan for rates rising, but with the understanding it's likely to be slow and methodical."
Given that, what's the best deal for a borrower who needs a mortgage now?
For most borrowers, there must be a strong reason not to get a standard 30-year, fixed-rate mortgage, because today's low rates offer a great opportunity to lock in a low payment for the long term. Given past patterns, there's little room for rates to fall significantly, but much room for them to rise. With an adjustable-rate mortgage, your payments could go up after resets begin in one, three, five or seven years.
"The 30-year fixed-rate loan is still the best deal for borrowers who believe they will keep the home for more than seven years, or who have zero tolerance for any increase in monthly payment, ever," says Brian Koss, executive vice president of EVP Mortgage Network in Danvers, Massachusetts.
But there are exceptions, so here is a look at today's loan landscape.
Rates are low -- really low. This has been true for so long that it's easy to forget that rates have often been two or three times higher. The standard 30-year fixed-rate mortgage charges an average of just 3.87 percent, according to HSH.com, the mortgage and housing data site. The 15-year, fixed loan averages 3.27 percent. The 5/1 adjustable-rate mortgage locks in at 3.05 percent for the first five years before beginning its annual resets.
Interest-only ARMs, loans with balloon payments, or those requiring no proof of income are things of the past, due to tightening of the loose lending standards that followed the financial crisis.
Getting a loan is easier. Though standards are much tighter than in the build up to the financial crisis, they're not as rigid as they were a few years ago. Borrowers with good credit can find loans with down payments of 10 percent or less, not the 20 percent that was all but universal after the housing bubble burst.
Because loan default rates, foreclosures and layoff rates have fallen, lenders aren't as jittery. So if your loan application was turned down a few years ago, try again.
It's still tough for self-employed people to get a mortgage, but not quite as bad as in the crisis aftermath. Your lender, for instance, might require you to submit just one year's tax return instead of two, says Mat Ishbia, CEO of United Wholesale Mortgage of Troy, Michigan. "It's harder than it was 10 years ago, because back then self-employed borrowers didn't have to prove their income or assets to qualify," Ishbia says.
Refinancing can pay. While most homeowners have fixed-rate loans, some have stuck with ARMs, often because they liked their low payments or thought they'd sell too soon to make the switch to a fixed-rate loan pay off. Sticking with an ARM was a winning strategy in recent years because adjustments did not raise rates significantly, if at all.
But if ARM rates do rise in the next few years, it may well be too late by then to lock in a great deal on a fixed loan. So this would be a good time to make the ARM-to-fixed switch if you expect to stay in the home for a number of years.
"Now is a great time to refinance," says Dave Jacobin, president of 1st Mariner Mortgage, a nationwide mortgage lender. "If someone believes they have enough equity in the property to refinance, and they know they'll be in the home for a long period of time, it might be a good opportunity to refinance for a 30-year fixed rate."
Know the trade-offs. The type of loan that's best for you depends on factors like how long you'll keep the home and whether you have extra cash to, for example, make the bigger payments required by a 15-year loan in order to get a lower rate.
"If a homeowner is going to move in four years, without a doubt, and wants to lower their payment, they may want to consider a 5/1, or 7/1 hybrid adjustable rate loan where the rate is fixed for five or seven years and then begins to adjust," says Matt Hackett, operations manager of Equity Now, a New York City lender. "This can save them considerably over a four-year period."
For those who can afford it, a 10- or 15-year fixed-rate loan can make sense because the interest rate will be slightly lower, and because you'd pay interest for only 10 or 15 years instead of 30. But compared to a 30-year loan, monthly payments will be much higher because the debt, or principal, will have to be repaid faster. For every $100,000 borrowed, the monthly payment would be $704 on a 15-year loan, or $470 on a 30-year, assuming the rates mentioned above.
"The big question about 15-year loan term is what type of savings and investments does the homeowner have currently," says Amy Tierce, regional vice president of Wintrust Mortgage of Needham, Massachusetts. "If they need to be saving for college or retirement, or need to save up a six-month cash cushion, then they should not take a 15-year with a higher payment."
Rates on 10- and 15-year loans are not much lower than on 30-year deals, so the rates themselves may not be reason enough to justify a long-term commitment to a much higher monthly payment.
Roland Narofsky, a regional vice president of Maine Savings Federal Credit Union of Bangor, Maine, offers a compromise: get the 30-year mortgage and make extra principal payments to pay the loan off early, reducing your interest payments over the life of the loan. It's almost as good as getting a 10- or 15-year loan, but without the commitment.
"If an unexpected long-term financial need arises, the borrower can back off to a minimum 30-year payment, and not have to incur additional refinancing costs to make their budget work," he says.
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