It’s been a while since I’ve uttered the word “refinance”, let alone, typed it out, but here we are.
2022 showed that applications to refinance a home fell to a 28 year low. Basically, no one refinanced. There was virtually no point as interest rates spiked up. And it’s not as though people are rushing to refinance today, but the conversations are being had more and more in anticipation of rates dropping. This is new. It’s not so common to chat with clients about the process of refinancing before they own a home. It’s like planning next year’s birthday before you’ve even celebrated this year’s birthday. But with the talk of inflation ultimately going down (fingers crossed) and the overwhelming common sentiment being that rates will follow; these conversations are taking place more and more. So let’s talk about it.
What is a refi?
The process of refinancing means the lender is taking one’s existing loan at one interest rate and replacing it with a new loan at a different interest rate. The lender will have to re-verify the clients’ income, assets, credit, etc. and ensure that they’re eligible to borrow the amount they’re applying for. In the overwhelming majority of cases, you can refinance from an adjustable-rate mortgage to a fixed rate or vice versa. If you’re looking to extend the term (i.e. going from a 20-yr fixed to a 30-yr fixed) or shorten the term (i.e. going from a 30-yr fixed to a 15-yr fixed), you can do that too. It’s crucial to ensure there is no pre-payment penalty attached to your loan. There shouldn’t be, but it’s worth checking.
When does it make sense to refi?
OK, great question. There are two types of refinances: a rate and term refi and a cash out refi. We’ll get to cash out refinances in a minute. Let’s talk about rate and term refinances which refers to refinances where you’re changing the rate (most likely lowering it) and extending or shortening the term. Here are a few examples of when it might make sense to do a rate and term refinance:
- You can lower your rate and save on your monthly payment
- You want to pay off the loan faster, so you shorten the term of the loan
- You want to lengthen the term and save money each month
- You’re going through a divorce, and you need to get your ex-spouse off the loan
- You have an ARM that is about to reset
- Get rid of private mortgage insurance (PMI)
Hang on, what’s this cash-out refi?
This is when you take an existing loan and replace it with a new loan at a higher amount, and the client walks away with the difference. I know, don’t worry, I’ll explain. Here’s an example. Let’s say I own a home worth $1M and I have $500K left on my existing loan. And let’s say that I want to do some renovations. It’s time to upgrade the kitchen, the floors and the bathrooms and it’s going to cost me $100K to do this. I can do a cash out refi, where I’ll replace the $500K loan with a new loan of $600K, the difference there being $100K. In this example, I would walk away with a check for $100K minus closing
costs. I would also have a new loan of $600K to pay back. The more equity you have in your home, the easier it is to do a cash out refinance. Aside from renovations, here are some other reasons to do a cash out refi:
- Use the cash out proceeds to pay off debt (credit cards, car loans, student loans, etc.)
- Use the funds to make a down-payment on another home purchase
- Take the cash and use it for investment purposes, whether that means investing in your business, someone else’s business, or another business venture
- Cashing out to pay for your kids’ college tuition
Anything else?
It’s important to know there are costs to refinance which can vary greatly based on the state and the type of property. For example, closing costs for a condo in NY will be higher than closing costs for a condo in FL. But closing costs on a coop in NY will be lower than the closing costs for that condo in FL. So, when the time comes, one of the first things we’ll do to determine if it’s the right time for you to refinance, is we’ll calculate your break-even point which is the point at which your costs equal the savings. To illustrate this, if my closing costs are $5,000 but I’m saving $300/mo., I’ll break-even in 16.67
months. $5,000/$300 = 16.67 months. The typical rule of thumb is if the break-even point is 24 months or less, it’s at least worth a conversation.
Are We There Yet?
There are still instances out there where people are refinancing in this environment – but those types of transactions are few and far between right now. But it’s just a matter of time before rates drop. And when that happens, refinancing might just make sense for you and I’d be happy to chat with you about it. If you have questions on any of this or anything else mortgage related, please feel free to reach out.
Vice President of Lending
CrossCountry Mortgage, LLC
C: 973.769.8180
scott.nadler@ccm.com
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