This year, Truepoint launched a new series of educational content featuring outside experts. The views below belong to the author, and as always, you can reach out to us with any specific questions. This month, Tim O’Brien of Zipfel Capital collaborated with Truepoint wealth advisor Adam Lipton to share the top things to consider when refinancing your mortgage.
On July 31, the Federal Reserve lowered the Federal Funds Rate 25 basis points in a much-anticipated move. As a mortgage broker, I’ve fielded many questions from our firm’s clients about this development. Specifically, people want to understand how this shift in policy impacts their mortgage and if the drop in the Federal Funds Rate is a trigger to refinance their current mortgage terms.
How does a Federal Reserve rate cut impact mortgage rates?
The short answer I give to my clients is to pay attention to the 10-year treasury bond rate. There is a common misconception that the Federal Funds Rate directly correlates to mortgage rates. Instead, the 10-year treasury bond is the main index lenders use to price mortgage rates. The reason? While most mortgages are 30-year products, those mortgages typically get paid off within 10 years, making it a great benchmark to determine where rates are going.
To provide an illustration, if you look at the 10-year treasury rate between January 2019 (around 2.75%) and early August 2019 (around 1.66%), that 100 basis point drop is a direct correlation to how the conforming 30-year fixed mortgage rate has performed. In January 2019, that rate was around 4.5% and in July 2019, that rate was in the 3.5% range.
Things to consider when refinancing
Knowing how the Federal Funds Rate movement and the 10-year treasury impact mortgage rates, let’s consider when it makes sense to take advantage of the changing rate environment. Here are the top questions to ask when considering a mortgage refinance.
1. How long do you plan on living in your home?
If you don’t envision owning your home for longer than 7-10 years, you might consider refinancing into a 10-year fixed Adjustable Rate Mortgage (ARM). A 10-year ARM is amortized over 30 years but offers a lower interest rate than a traditional 30-year mortgage for the first 10 years. This can be a great way to save on interest payments. For example, if you compare a $1 million loan with a 30-year fixed rate at 4.25% to a 10-year ARM at 3.125%, there is an interest savings of nearly $107,000 over 10 years. Typically, you can refinance as much as a $3 million loan balance into this type of loan.
2. Do you have a second mortgage or other unsecured debt?
If you currently have a home equity line of credit (HELOC), not only does it carry a variable interest rate, but you may not be receiving an interest deduction based on the Tax Cuts and Jobs Act of 2017. Therefore, we recommend clients who have a balance on a HELOC consider consolidating that debt into a first mortgage loan. This allows a borrower to both lock in the interest rate for their debt and ensure they can deduct as much interest expense as possible per tax guidelines. As always, it’s helpful to get guidance from your tax advisor on this scenario.
3. Do you plan on renovating your home?
Many clients choose to renovate their existing home as opposed to buying new. There are renovation loans you can use to finance both small and large-scale home renovation projects. A lender will take your contractor’s budget, plans, and specs and have an appraiser provide a “subject to improvement value.” For example, if you own a $500,000 home and invest $200,000 in improvements, the appraiser would value the home as if that work had been finished. The lender will lend you up to 80% of the “subject to improvement value.” If the home were to appraise for $700,000, that means you could borrow up to $560,000 on a first mortgage to finance the renovation project.
4. How much lower does your rate need to drop for a refinance to make sense?
There isn’t a perfect answer to this question, however, there is a general rule of thumb you may consider. If you can recoup the fees associated with your refinance within 12 months, through reducing your monthly payment, that is typically enough justification. For example, say you own your home, have a $400,000 mortgage balance, and your interest rate is 4.5% on a 30-year fixed mortgage. You see that the 30-year fixed rate has dropped to 3.625% and, based on your circumstances, could take advantage of that rate with $2,000 in loan fees. By refinancing, the reduction in your monthly principal and interest payment is $230. Over 12 months, that’s a savings of $2,760, which is more than your investment of $2,000 in loan fees.
What is not advisable when refinancing is investing large sums of money in loan fees and points that takes years to recoup. Keeping your fees low enough to recoup the investment within the first 12 months ensures you’re making a sound decision with a short return on investment.
As you can see, the reasons to pay attention to rate changes are many and varied. However, making the decision to move forward can often be paralyzing as you try to determine the right time to pull the trigger on refinancing. Your advisor or a trusted partner like Zipfel Capital can help you understand the opportunities that may help in your decision and could potentially help you save in interest payments. Please contact our team if you have any questions about your current mortgage situation.
About the Author
Tim O’Brien is an equity partner in Zipfel Capital, a mortgage brokerage company based in Hyde Park, specializing in residential and commercial lending. Tim has been acknowledged by the Greater Cincinnati Mortgage Bankers Association (GCMBA) as a Diamond Level Producer, given to less than 1% of industry professionals. He has also been featured in the Cincinnati Business Courier’s “Ask the Expert” series. Tim holds a bachelor’s degree from Xavier University and is a graduate of The Summit Country Day School. He lives in Mt. Lookout with his wife and three children.