Refinancing a mortgage today is a smart move because interest rates have fallen to 6-year lows in 2020. With trade war tensions with China, the potential start of war with Iran, Brexit, and jitters about whether a 10+-year bull market will continue in stocks, interest rates have remained suppressed.
Lending standards are also strict with ~740 being the average credit score for denied mortgage applicants in 2020. With such high lending standards, it makes me confident that the next housing market correction won’t be nearly as bad as the last one.
Homeowners have gained a huge amount of equity since 2012. They aren’t going to foreclose or short-sale for nothing. In fact, I think 2020 and beyond is a good opportunity to buy real estate due to rising affordability and an underperformance compared to the S&P 500 in 2019, which was up 31%.
I’ve refinanced multiple mortgages across multiple properties since 2003. Here are my strategies for how you can get the lowest mortgage rate possible.
How To Get The Lowest Mortgage Rate Possible
1) Pressure your existing mortgage lender: The easiest course of action is to ask your existing mortgage lender if they can lower your mortgage rate. After all, they don’t want to lose your business to a competitor.
I called Citibank, the bank that has my $1 million loan, and asked what they could give me. They first said 3.125% for a 7/1 ARM, which was OK, not great. I pressed them to give me a deal as a CitiGold client, so they brought the rate down to 3%. Not bad, but I wanted under 3% with no fees. So I told them I’d get back to them.
2) Shop around online: I then filled out my mortgage details on Credible, a leading mortgage comparison marketplace to see what their lenders could come up with. I like Credible because they provide real mortgage quotes from pre-vetted, qualified lenders who are competing for your business. Within three minutes of filling out the application, I was contacted with mortgage rates between 2.75% – 3%.
I wanted to use Credible to make sure Citibank was indeed providing a good rate. Some of the Credible-referred bankers said they could beat 3%, so I knew there was more wiggle room for me to negotiate.
3) Track down your old mortgage officer: The mortgage officer who first helped you refinance your loan might have moved elsewhere. If so, track him or her down and tell him or her you’d like to do business.
Mortgage officers at new banks would love to win over business from their old bank. As a result, they may often given you a better rate. It’s worth starting a new application with a new bank so you have something in writing to negotiate with your existing mortgage lender.
4) Dangle the carrot: Banks are all about cross-selling you products. Not only do they want to refinance your mortgage, they’d also love for you to open a savings account, a business account, an investment account, a Home Equity Line of Credit, and more.
You want to dangle the carrot by telling the lender that if they match or beat a certain rate, you plan to open up several new accounts. As good faith, you can open up a simple account such as a savings account, especially if they have a promotion.
Banks want sticky clients with multiple accounts for cross selling and revenue generation purposes. There is no legal quid pro quo that banks can use to get you better terms. But every big bank has a tiered client system in place where clients with more assets get better access, rates, and benefits.
Always Refinance Your Mortgage When You Can
We live in a goldilocks scenario where not only have real estate prices and stock prices gone up since 2009, mortgage rates have come down. Always refinance your mortgage when you can breakeven in under 18 months and plan to own your property for years to come.
My favorite way to refinance is through a no-cost refinance. The lender pays for all your fees so that as soon as your new mortgage closes, you’ll be saving money immediately. There’s technically no such thing as a no-cost refinance since the borrower ends up paying a higher mortgage rate. But if the new mortgage rate is lower than your previous mortgage rate, then you’ve got nothing to lose refinancing, except for your time.
Let me share some more information that I think will help every single mortgage refinancer and borrower around.
Inflation And Mortgages
Knowing when to refinance is like being a bond trader. Bond traders obsess over inflation assumptions, and you should have at least a basic assumption as well. There has been tremendous monetary expansion since the economic downturn, which should ultimately lead to higher inflation.
Basic economic theory says that for every new $1 dollar bill printed, there will eventually be a $1 increase in prices in the overall basket of goods. The key word is eventually, which could be decades away.
So many Wall Street veterans have gotten inflation and interest rates wrong over the past decade by calling for a rise in interest rates. I am a firm believer that interest rates will stay low for a very long time because there’s still a lot of slack in the system, a lot of volatility in the global markets, and there’s also very efficient monetary policy around the world thanks to technology.
Technology and diplomatic relationships allow Central Bankers to coordinate monetary policy in an effective manner to guide desired inflation and interest rates. When Central Bankers don’t coordinate, like when the Swiss government decided to depeg from the Euro, that’s when chaos ensues.
Those with adjustable rate mortgages (ARMs) are this century’s winners because rates are resetting at equal to lower levels than when they were originally fixed. Those who’ve been borrowing with 30-year fixed mortgages have been losers because they’ve been paying 1-2% higher interest rates than necessary.
Sure, there is perhaps more peace of mind knowing that your mortgage interest rate is fixed for the life of the loan. But most people either pay off their loans in under 30 years or move every seven years. Bankers push people into fixed rate mortgages because they can earn a higher spread.
Inflation has been coming down now for over 30 years, and I see little reason to expect inflation to suddenly jump higher given the tremendous output gap in the economy. If inflation does start rising, at least you know that your assets are by definition also rising in nominal value.
The figure to watch is the 10-year US treasury yield. The spreads between treasury yields and bank mortgage rates have narrowed since the crisis. Most long term duration mortgages are related to the 10-yr bond yield, hence whenever you see the stock market crashing, watch bond prices rise, and yields fall. This is the exact time to refinance.
Duration And Mortgages
In an ideal world, it’s best to match the time it will take for you to pay down your mortgage and the fixed duration of your mortgage once you’ve made assumptions about inflation and interest rates.
For example, if you need 30 years to pay off your mortgage, then it’s probably most prudent to get a 30-year fixed mortgage, even though the interest rate is higher than an ARM mortgage.
But let’s say you’ve got assets elsewhere you could easily sell to pay off your mortgage if you wanted to. Then, you should consider getting as short a duration mortgage as possible to save on interest cost.
For example, many multi-millionaires I know borrow based on a 1 year ARM where interest rates are 50 basis points lower than a 3/1 or 5/1 ARM. If interest rates rise drastically after the 1 year ARM is over, the borrow can simply choose to pay down the mortgage.
If you look at mortgages in places like Hong Kong and Singapore where property fever is high, almost everyone borrows at a 1 year fixed rate that floats after. The US is a special country which not only has mortgage interest deductions, but also fixed rate loans of varying lengths.
Given the yield curve is generally sloping, longer duration loans have higher interest rates. This is a truism for the most part, except during times of extreme economic duress, where the yield curve flattens, or inverts given people want their money as liquid as possible. Assuming a normal upward sloping yield curve, you will pay a higher rate for a longer duration mortgage.
However, in 2019, the yield curve inverted, portending to a potential economic slowdown. When the yield curve flattens or inverts, you must take advantage of borrowing at longer durations and saving at shorter durations.
Short-term rates are rapidly equaling long-term rates
Refinancing Costs
The are a bunch of costs that go into refinancing, which unfortunately eat into the savings of refinancing. The way to think about costs is to get the total cost of refinancing divided by the monthly savings of refinancing to see how many months it takes to break even.
For example, let’s say it costs $3,000 to refinance a $400,000 loan from 5.25% to 4.25%. Your monthly payment goes from $2,375 down to $2,135 for a savings of $240. Take the $3,000 in refinancing costs divided by $240 = 12.5. In other words, it takes 12.5 months for your cash flow to start benefiting from a refinance.
If you plan to take 360 months (30 yr fixed) to pay off your mortgage, your actual savings would be $83,400 (347 months X $240) making the $3,000 cost to refinance a no-brainer. Ironically, you save less if you pay off your loan quicker from a refinancing stand point. From a bank’s point of view, this is called “prepayment risk.” They don’t want you to pre-pay because they want to make as much money from you for as long as possible.
Savvy readers will realize that there’s a difference in cash flow savings vs. interest savings. Even though my $1 million mortgage refinance will drop down to a $3,882 a month payment from $4,338, the $456 a month savings is not all interest savings because I’ll be paying less principal as well.
The easiest way to calculate the interest savings is to take the mortgage amount and multiply it by the difference between the interest rates e.g. $1,000,000 X (2.625% – 2.25%) = $3,750. Now take the cost of refinance and divide it by the interest savings to calculate a truer break even number.
You can also ask your mortgage officer what the cost would be to refinance at a higher rate. In this example, you could get a “credit” to your costs if you refinanced for 4.75% instead of 4.25%, thereby having less money leave your pocket.
The general rule of thumb is that if you plan to stay in your house for over 5 years, and it costs no more than 20 months until you break even, you should refinance. I personally shoot for a break even cost of less than 12 months.
Below is a sample of various refinance fees you may have to pay:
The Pain To Refinance Factor
It would be nice if one could just snap one’s fingers and change the terms of a loan. Unfortunately, it’s not that simple and you need to spend at least five hours of your time speaking to your mortgage representative and preparing and signing the paperwork.
Further, the whole mortgage refinance process could take more than three months, as was the case with my previous mortgage refinance. A good agent should be able to tell you all the necessary documents you need to get things going.
The mortgage process generally takes about a month and a half given the bank needs to pay off the loan, send an appraiser to figure out the loan-to-value ratio, check your income and assets, go through the title company to get the proper documents, pull insurance records from the homeowner’s association, and get you to sign everything. It’s the underwriter who is going to give you the hardest time, so be prepared for battle.
The less you make, and the less busy you are, the more you should look into refinancing! If on the other hand, you’re happy with your loan, don’t have a lot of time, and make a ton of money, your time is worth more than the headache you will go through to save $16,000 bucks in the example above.
THINK LIKE AN INVESTOR
A lot of people think that all debt is bad. These are probably the same people who probably haven’t been able to successfully leverage debt to build their net worth as much as they could. I do believe that too much debt is bad. The banks have determined that having a debt-to-income ratio of over 42% will not qualify one to refinance or get a loan.
As an investor or CEO, one of your goals is to utilize the right mix of debt and equity to provide the highest return on equity possible. The key is to not take on too much of either to avoid risk of insolvency. When interest rates are low, borrowing money becomes cheaper than raising money through equity. When interest rates are high and equity valuations are low, the reverse is true.
If you are a mortgage borrower, then you actually want inflation to come back. Inflation means your underlying assets – in this case your home – is inflating at a higher rate than before.
You want inflation as an asset owner. Meanwhile, inflation will pull interest rates higher, making your mortgage that much more valuable to HOLD. If you paid off your 2.75% mortgage and decide you want to borrow money again in an interest rate environment that’s now at 5%, you’re hurting.
In other words, taking out a mortgage for X amount is like SHORTING a bond for X amount. Bond values fall in a rising interest rate environment because investors sell bonds in favor of higher interest yielding bonds.
Bottom line: Do everything possible to refinance your mortgage when you see an opportunity. With rates at 6-year lows in 2020, refinancing now is a smart move.
Recommendations
Shop around for a mortgage: Check the latest mortgage rates online through Credible. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible from them or your existing bank. When banks compete, you win.
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