Mortgage Refinancing 101

Sep 9, 2020 Willow Creek Wealth Management Posted in In the News

You may have been hearing a lot about mortgage refinancing during the pandemic, and with good reason: the Federal Reserve has dropped interest rates twice to stimulate the economy, which has led to historically low mortgage rates. But if you are considering a refi, you might want to act sooner rather than later. The Government-Sponsored Enterprises (GSEs) that provide liquidity by buying 70% of mortgage loans have introduced a surprise “adverse market” fee to recoup billions of dollars of losses resulting from COVID-19. Fannie Mae and Freddie Mac’s 0.5% fee was supposed to be effective in September, but due to pressure from consumer groups, lenders, and politicians, the Federal Housing Finance Agency (FHFA) has instructed the GSEs to postpone implementation until December. So now is the time to lock in a lower mortgage rate before the adverse market fee kicks in. But before you refinance, you should make sure that it makes sense for you. 

Should you refinance?

  • If you have an ARM (Adjustable Rate Mortgage). ARMs readjust at the end of their term based on a benchmark interest rate and the lender’s margin percentage points. So if you are near the end of your ARM term, rates are lower than your current loan, OR you would benefit from the stability of a fixed loan, and you plan on staying in your house long enough to pay off the closing costs, you should consider refinancing.
  • If your interest rate would be 1-2 percentage points lower. As of the beginning of September 2020, mortgage rates are in the range of 2.5% to 2.99%, so it will likely benefit you to refinance if your current rate is anything above 3.5 to 4.0%. But be sure to consider the overall cost of a new loan, if it increases the term of the mortgage, and that you will be in the house long enough to recoup any closing costs.
  • If your term would be shorter. If you can shorten the number of years for a mortgage to be paid off, the interest rate is usually lower, and you could save significantly on interest payments as you are paying off the loan much more quickly. However, you should always consider the flexibility of a longer mortgage with lower monthly payments if there is the possibility of instability in your income. If you have the discipline, you can always make extra payments to reduce the principle and save money that way.
  • If you plan to stay in your home long enough to recoup refinance costs. Even if you reduce your monthly payment, shorten the loan term, and pay less interest over the life of the loan, you will still want to calculate what is called the break-even point. You do this by dividing the total loan costs by the monthly savings. For example, if you end up paying $4,000 in closing costs and lower your monthly payment by $300, it will take you 13 months to “break-even." There is no benefit to refinancing your home if you won't recoup the loan costs before you plan to sell, however low the interest rates are.

What documents will the mortgage broker need?

It will be important for you to work quickly, gathering the appropriate paperwork to lock in the best rate you can. You cannot assume that this will be a speedy process; with historically low rates, the demand for refinancing is high, so mortgage brokers, appraisers, and others involved in this process are backlogged with requests. Expect even the smoothest process to take around six weeks from start to closing. Every refinance process is unique, but common documents needed could be:

  • Current mortgage statement
  • Homeowners insurance policy
  • A few months of bank and/or investment statements
  • Recent paystubs
  • W2s and Federal Tax Returns for the last few years
  • Most recent 401(k) or retirement plan statements

What are mortgage points, and how do they work?

Another way to reduce your mortgage interest rate is to "buy down the rate" by paying a fee directly to the lender at closing. One percentage point costs 1% of the mortgage amount, so $1,000 for every $100,000. For example, to lower the interest rate 0.5% on a $200,000 loan, the lender would add .5 “points” (equal to $1,000 or 0.5% of $200,000) to the closing costs. The lender is paying some interest up front in exchange for a lower rate over the life of the loan.

What should I know about the Adverse Market Refinance Fee?  

  • Who pays the fee? The lender is assessed the fee, but ultimately it will mean that the cost of refinancing will go up by increasing the loan amount. Surprisingly, the assessment does not affect purchase mortgages. The FHFA indicated that GSEs did not want to negatively affect the housing market. Jumbo loans are also exempt, along with FHA, VA, or other loans that don’t have to meet Fannie or Freddie’s standards.
  • How will it affect the average borrower? Lenders raised refinance rates earlier this month in anticipation of the new fee. It is estimated that the refinanced loan amount will increase by an average of $1,400. This may put a damper on refinance activity as it becomes less worthwhile for the consumer to refinance. Due to protests, the FHFA did instruct Fannie and Freddie to exempt loan balances below $125,000 and loans made through the HomeReady and Home Possible affordable refinancing programs (in deference to low-income Americans).
  • Why are they doing this? GSEs have said the new adverse fees are necessary to help pay for the support they provide in forbearance programs and moratoriums on foreclosures and evictions during the pandemic. Fannie and Freddie make the case that they need to generate income to move out of the conservatorship they entered in 2008 after the last financial crisis. Critics question the timing of this decision.
  • Has this happened before? Fannie and Freddie tried to access a 0.25% fee in 2007 as the Great Recession unfolded. While they don’t directly interact with mortgage borrowers, they guarantee more than half of American mortgages by purchasing the loans from lenders, packaging them, and selling them to investors. Their argument has been that the adverse market fees will not increase the borrower’s monthly payments, but will simply reduce the savings from refinancing. The GSEs also theorize that the lenders are experiencing higher profit margins and will not necessarily increase loan costs. Most analysts disagree, anticipating that the fee will be passed on to the end consumer – the borrower.

Does it Make Sense For You?

So while there are many considerations involved in deciding to refinance or paying off your mortgage, you will want to see how either move affects your long-term financial situation before you take action. Besides the loan itself, you will want to consider any other debt you may have, whether you have an emergency fund for life events and unexpected home maintenance, and what your risk tolerance is for long-term investing. Paying off a mortgage rather than investing, for example, may be enticing during economic uncertainty and market volatility. You may want to contact your financial advisor to help you address these issues to make the best decisions to reach all of your financial goals.