One of the questions people ask me most often is whether or not it is a good time to refinance a mortgage. When you think about it, this makes perfect sense. Mortgage debt is usually a person’s single largest liability. And one of the largest monthly expenses. So when does it makes sense to refinance your mortgage?
The Changing Lending Landscape
Over the last couple of months, the lending landscape has changed dramatically. We are just now learning some of the second-order effects of the Coronavirus. We are also learning of some of the unintended consequences of the CARES Act.
Mortgage Payments
One goal of the CAREs Act was to help individuals impacted by the Coronavirus that were having problems making their mortgage payments.
Postponing Payments
The two government-backed entities–Fannie Mae or Freddie Mac–own 70% of home mortgage loans in the U.S. If either owns your loan and COVID-19 financially impacted you, you are allowed to postpone your mortgage payment up to 90 days. And borrowers can extend that original extension of 3 months out to one year. But it has to happen in three- or six-month increments.
Here is something to keep in mind. There is a difference between who owns your mortgage and who services it. You may make your payment to a local bank, but the chances are that they don’t own your mortgage. You can look to see whether Fannie Mae or Freddie Mac owns your loan by checking out the Making Home Affordable government site.
Forbearance not Forgiveness
Forbearance does not mean forgiveness. Any amount postponed must be repaid. There has been a lot of misinformation surrounding how much must be repaid. Yes, the entire amount could be due as a lump sum. But if your mortgage is owned by Fannie Mae or Freddie Mac, that is only one of several available options. It is possible that at the end of the forbearance period to have (1) the missed amounts added to the end of the original term of the mortgage, (2) the loan modified to lower monthly payments, or (3) a repayment plan where you make payments over several months. As of the end of May 3rd, the Mortgage Bankers Association reported that 7.9% of home loans were in forbearance. This is more than double the percentage of mortgages the defaulted in the Global Financial Crisis.
Devil in the Details
For credit reporting purposes, mortgage forbearance does not impact your credit score. Reporting agencies do not view skipped payments as delinquency. However, a mortgage forbearance does count as a gap in payments. Why does this matter? If you later decide that you want to refinance your home mortgage, it will need to go through underwriting. You will not be able to refinance your mortgage if you have skipped more than two consecutive payments on a government-owned mortgage over 12 months. For this reason, you should see if it makes sense to refinance your current mortgage before you opt for mortgage forbearance.
[edit] On May 19th, the Federal Housing Finance Agency announced additional guidance for those borrowers who have a Fannie Mae and Freddie Mac loan. If borrowers went into COVID-19-related forbearance, they are now allowed to refinance or buy a new home once they have made three straight months of payments after they exit forbearance. This essentially shaves nine months off the waiting time.
Home Equity
The Federal Housing Finance Agency’s House Price index measures the changes in single-family house prices for the U.S. Over the past decade, home prices—nationally—have increased by about 4.25% per year. For many individuals, their single largest financial asset is their home. With the increasing uncertainty that has come with COVID-19, it makes sense that many Americans would look to tap the equity of one of their largest assets. The easiest way to do this is to use a home equity line of credit (HELOC).
HELOCs are a No-Go
On May 8th, the unemployment rate was reported to be 14.7%. As you can imagine, this has made banks more than a little nervous. So much so that Wells Fargo and J.P. Morgan have both announced that they will no longer allow new applications for homeowners to borrow against the equity in their homes. So far, no banks have changed the terms to existing home equity lines of credit.
Cash-out, But It Will Cost You
If you have refinanced in the past, you may have been given the option to tap into some of your existing home equity. The additional amount borrowed is simply rolled into your new loan. With the uncertainty surrounding COVID-19, many large banks have stopped allowing cash-out refinancing. If you have lenders that still allow for a cash-out refi, expect to pay up. A cash-out refinance could add a price adjustment of 5% to your loan rate. Additionally, many banks are also requiring that borrows have a minimum FICO score of 700 and 20% equity in the home.
Home Rich, Cash Poor
The main takeaway should be that current lending standards have tightened significantly over the last two months. Using the equity in your home has just gotten much more expensive and is no longer a viable option for most individuals. It may be best to look at other options or wait until lending standards begin to loosen.
Should I Refinance?
Although it may not make sense to do a refinance to pull the equity out of your home, it can still make sense to refinance to help with the monthly cash flow?
What are Your Cash Flow Needs?
To know whether it makes sense to refinance or not, you need to answer whether you are looking to save money in the next few years or over the long-term. Except in a few rare cases, you will probably incur closing costs to refinance your mortgage. These costs can range anywhere from 1% to 5% of the loan amount. They are typically rolled into the new mortgage and paid over the new 15 to 30-year term. This may be the best option for someone that needs help now with their cash flow and has no other alternatives.
Count the Cost
Anytime I analyze a mortgage refinance, I always do a breakeven analysis. First, I figure out how much it will cost to refinance the loan. I then look to see how much difference there will be in the monthly payment before and after the refinance. Let’s say I have a mortgage with a balance of $210,000 with an interest rate of 3.99%. The monthly payment is currently about $1,200 per month.
If I can refinance at 3.25% for 30 years, my monthly payment would drop to around $900 per month. That could potentially save me about $300 per month. Let’s say that it cost me $4,000 to refinance. It would take me approximately 13 months to breakeven or recover that cost ($4,000/$300=-13.33 months).
Context is Key
It seems straightforward, right? Not so fast. What I didn’t mention is that I have had my current mortgage for eight years. If I refinance into a 30-year loan, I am adding eight more years of payments and $5,000 of closing costs. With that context, is it still such a great deal?
An Example
Here is what I like to do. I imagine that I have taken my current loan and refinanced it into a new 30-year mortgage. I assume that I owe the same amount ($210,000) and that the interest rate is the same, 3.99%. If I were to do this, my monthly payment would be about $1,000. (If you need a simple mortgage payment calculator, Bank Rate has one). I like this approach because it helps me have a clearer picture of how long it will take to breakeven.
In my example, refinancing may only save me $100 per month. If my closing costs are $4,000, it could take 40 months to breakeven. Depending on the details of my situation, it could still make sense to refinance my mortgage. But if I don’t need immediate help with cash flow or plan to move with the next four years, it might be wise to wait.
Conclusion
COVID-19 has introduced a level of uncertainty in our everyday lives on an order that has rarely been seen. Refinancing your home mortgage may help you deal with some of the financial uncertainty. But the lending landscape is continuously changing. Make sure that you identify your goals and determine whether or not a refinance will help you achieve them.
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