Rate Are Coming Down...BUT...
There has been considerable discussion regarding the potential and timing of rate reductions. While the future remains uncertain, it appears that the federal government may be prepared to lower rates to stabilize the US economy. As homeowners, debt holders, and investors, it is imperative to closely monitor market conditions to determine whether any action should be taken. Mortgage rates are no exception, but lower rates generally benefit borrowers.
Your Objective
The initial step for a homeowner with a mortgage is to identify their objective. We all have goals, which can be categorized into short-term and long-term objectives. Short-term goals require immediate attention and may involve addressing excessive debt, such as credit card balances. A cash-out refinance can alleviate the monthly burden of servicing this debt by utilizing the equity in your home to pay off those debts and adjusting your monthly payment accordingly. If you have a low-interest rate on your mortgage, a HELOC or second mortgage may be the most suitable option.
Long-term goals are those that you aspire to achieve but may take five, ten, or even twenty years to accomplish. The earlier you plan, the more options you have. For instance, I am planning to retire from teaching in seven to ten years. My goal is to have my mortgage close to being paid off. If I can accelerate my payoff schedule (amortization), I can gradually reduce my outstanding balance over those years. The state of Illinois has essentially made pre-payment penalties illegal, so any balance reduction not only reduces the remaining amount owed but also directs more of your monthly payment towards principal reduction rather than interest. There may be other long-term goals, but only you can determine what you truly desire. If you can leverage your property ownership to your advantage, why not?
It Extends Beyond Just a Rate
Indeed, a lower interest rate enables you to make smaller payments and acquire more property. However, there are additional factors to consider beyond the interest rate itself. If you are purchasing your first property, the interest rate is determined by the prevailing market conditions during the property acquisition process. Conversely, if you already own property, refinancing involves more than just a lower interest rate. When contemplating refinancing, it is crucial to prioritize the client’s short-term and long-term objectives.
While a lower interest rate is beneficial, resetting your amortization schedule can be a hidden cost. Mortgage brokers often present a lower payment that appears even more favorable than anticipated. This is because the lower interest rate is accompanied by a reset of the payoff schedule. For instance, if you are five years into your mortgage and refinance to a 30-year mortgage at the same rate, you effectively add another 60 payments. If your original mortgage was for $350,000 at 6.25% interest over 30 years, your monthly payment would be $2,155. After five years, the balance would have decreased to $326,680. Refinancing this amount at the same rate on a 30-year amortization schedule would reduce your monthly payment to $2,011, resulting in an apparent savings of $144. However, this is merely an extension of your repayment period by 60 months (five years). While this may align with a short-term goal, it is essential for clients to recognize this crucial information, as many loan officers fail to highlight this potential drawback.
To accurately assess the savings, it is advisable to calculate the new payment based on the remaining years of your mortgage and the revised amortization schedule. In the aforementioned example, if interest rates decreased to 5.25% from 6.25%, with 25 years remaining on the mortgage, the reduced payment would be $1,958, resulting in a savings of $198. An inexperienced loan officer might incorrectly claim a lower payment of $1,803.94, which would incur an additional $108,236 in payments over the extended period.
When To Take Action
The optimal timing for refinancing depends on individual circumstances. Generally, if the reduced monthly payment aligns with both short-term and long-term financial objectives, it is advisable to proceed with refinancing, but with careful consideration.
If interest rates are declining, it is recommended to utilize the program that offers no costs for refinancing. Although the interest rate may increase by 1/8 or 1/4 percent, the primary objective is to minimize expenses. Currently, interest rates are at a peak, and many believe they will decrease for several months.
If refinancing today results in a 1% or 2% reduction in interest rates, it is prudent to avoid incurring refinancing costs until the loan breaks even. In other words, you can adjust your interest rate as the market fluctuates without incurring refinancing expenses. However, if you anticipate that interest rates will remain at their current level, it is advisable to complete the traditional refinance and pay the associated costs to secure the lowest possible interest rate. While this may involve upfront expenses, it is expected that you will break even within a few months and achieve minimum interest payments.
In some cases, taking no action may be the most prudent decision. For instance, you can simply amortize the remaining balance of your payoff schedule and begin making regular payments. In Illinois, conventional loans are exempt from pre-payment penalties, and any additional funds in your mortgage payment must be applied to the principal balance. Consequently, the interest due for the subsequent payment will be based on the reduced principal balance, resulting in a smaller portion of your payment being allocated to interest.
While this information may be extensive, it is crucial for my clients and you to be well-informed to make the most suitable decision for your financial security. Should you have any inquiries, please do not hesitate to reply to this email or contact me directly at (847) 556-9326.