Published November 18, 2020
It might not make sense to go through this process, pay those fees, and then not be there long enough to break even and recuperate that cost.
It might not make sense to go through this process, pay those fees, and then not be there long enough to break even and recuperate that cost.
With mortgage rates at historic lows, refinancing has become a hot topic—but is it the right move for you?
In this episode of The Adviser You Can Talk To Podcast, Senior Financial Planner Andrew Busa, Account Executive Dina Milne and Vice President Rick Winters (all Certified Financial Planner™ professionals) go through the top five questions to ask yourself before refinancing the mortgage on your primary residence. The trio teams up to tackle the following topics:
Refinancing can be a fantastic opportunity to save some money or free up cash for other purposes, but a misstep could be costly to your long-term financial plans. Click above to hear our experts’ answers to your most pressing refi questions today!
For more on refinancing, check out our blog post on the subject.
Hello, this is Andrew Busa and I’m a financial planner at Adviser Investments. We’re here with another The Adviser You Can Talk To Podcast. And today I’m joined by my colleagues, Dina Milne and Rick Winters. They each manage client relationships here at Adviser Investments.
Today we’re going to give you five questions to consider when thinking about refinancing. So when interest rates drop, this immediately becomes a hot topic on news outlets and personal finance websites. And you’re probably seeing advertisements to trade-in your old interest rate for a new one, but we’ll find out today that there’s more nuance to it, right? Dina, what are some of the reasons you’re seeing as to why people are looking to refinance?
There are really three main reasons why people refinance. The first one is lower interest rates and you already mentioned that. Whenever the rates drop, this is a great opportunity to get a cheaper loan. When you initially set up that mortgage your rate might’ve been a couple of percentage points higher. And the lower rate is definitely going to give you better cash flow and give you a lot of advantages. A second reason is with a lower interest rate, you get a lower payment. As I mentioned before, you’ve got better cash flow. You can redirect cash to, if you want to save it, if there is a project that you want to put money into, that’s definitely going to be a great advantage.
And then the third point is a lot of people like to use the equity in their home to finance other projects. For example, if you want to do a renovation, renovations are fairly expensive especially if you’re doing a kitchen or a bathroom, so if you’ve got equity in your home and you’ve already paid down a lot of your mortgage, you can actually use that equity to finance that renovation. Many people also who have kids that are going to college and they want to help them out with their tuition, they can also use that equity in their home by refinancing and using that extra cash flow to pay for tuition and other big expenses that they want to pay for.
We’re really starting to see why refinancing can be such a powerful financial tool. Before we dive into the five questions, Rick, I want to tip it over to you to just unpack some advanced terminology that’ll really help us lay the groundwork for today’s episode.
I think it was important to just highlight a couple words that you may hear and just give you some general meaning. We’re not going to be able to pull them all apart today, but just want to make sure that as you hear some of these things, you may want to look into them and understand a little bit better. One is the terminology of points. What is that? It’s mortgage points or fees just paid directly to the lender at closing in exchange for a reduced interest rate that sometimes is required. Closing and settlement costs, that’s just associated with the completion of a sale or purchase of real estate. You’re going to have that when you’re sitting down signing the papers. You’re going to have to pay some money. Taxes, property taxes, depending on where you live, they may be more or less.
Insurance, your property, your mortgage company is going to want you to have insurance. You’re going to want to have it as well. And then interest rates. When we talk about interest rates, which will come up a lot today, where there’s the difference between a fixed-rate mortgage and variable-rate mortgages and higher or lower interest rates, and then the mortgage term, which will affect all of these things for 15 years, 20 years, 30 years. So, as you hear these, just understand that there’s maybe more that you’ll need to look into, but just to give you a quick starting point to work from.
Yeah, that’s a great foundation. And one more caveat to throw in here. This podcast is geared towards primary residence refinancing. Some of these concepts might apply to an investment property or a vacation home, but the considerations for those are going to be a little bit different so just keep that in mind. Without further ado, let’s dive into these five questions to consider before refinancing and the first to really play off of each other and you’ll see that. Number one is, what are the fees? Dina, I’ll let you take this one away.
As you know, nothing in life is free. When you’re going through a refinance process, it’s basically like applying for a mortgage from scratch. It’s going through the process all over again. Any costs that you remember having to cover when you initially set up that mortgage, like your titling fees, appraisal, any kind of legal fees, closing fees, there are fees to this process.
The lender or the bank will be very clear, they’ll break it down and they’ll give you a breakdown of these fees. They could be as low as $3,000 to much higher than that. The nice thing is that many lenders can wrap this fee into the new mortgage balance so you don’t actually have to pay it out of pocket. They’ll just add it to the mortgage balance, but remember that by adding it to the balance, you’re paying interest on that.
And the other option is you can pay the closing fees out of pocket. I think the important thing to consider when you are doing a refinance is what these fees are. Let’s imagine that you’re paying $3,000 in closing fees and then your new mortgage payment under the refinance is saving you about $200 a month. And so you would probably make up this cost, the $3,000 that you paid to refinance, you’d make it up in a little over a year. So that could be a worthwhile process.
Yeah. That’s definitely part of the calculation. As you think about making this transition, it’s trying to improve something or give you access to some money. So as you think about some of these upfront costs, there is a recovery period. When do you actually break even?
Right. Ultimately what we’re talking about here with refinancing, you’re trading in your old mortgage for a new one. To your point, Rick and Dina, you’re not going to want to do this unless it helps you financially. I also want to throw in with this question here. You know the difference between the contract rate and the APR, right? Because the APR is actually what you’re going to be paying, the annual percentage rate. What’s advertised, that could be a different story. When you’re talking about fees, that’s really what you’re going to be focused on. What’s your APR?
That goes back to knowing the terminology. We can fully pull that apart for each person and your unique situation, but it is, yeah, you just read the fine print.
Take some time. This is one of the biggest transactions that you’ll ever make in your lifetime. Maybe many times in your lifetime if you’re moving and making different purchases or refinancing like we’re talking about today. Take some time to get to know the terminology and really pull apart those costs. People don’t do things for free. You’re going to have to pay for the services you’re receiving. We don’t want to make it sound like it’s a daunting thing. Just know that when you get down to signing the papers there are costs for each of those signatures you write that day.
When it comes to recouping those costs over time, Dina, you already touched on a little bit, this is a good transition into the second question to consider, and that’s going to help you consider what your break-even is. Number two is: How long are you planning on staying in your current home?
This is one of my favorite topics, because it’s asking you to look far into the future. Since lately, so many times, we’re talking about 15- or 30-year mortgages here and tell me exactly what’s going to happen.
That’s almost impossible.
The crystal ball.
Yeah, the crystal ball. One example that I think I can start with here, because this is where most people are walking into their first house is that you’ve made first purchase.
It’s just you and your partner, your wife, or your spouse, and you’re making your first purchase. And you’ve got all these plans of all these things that could happen, but you can’t afford the biggest house you’re ever going to own yet. So you buy your house that you’re going to have to transition. In a couple of years, everybody’s sitting here saying, it’s time to refinance and you’re thinking, well, I’m probably going to move in the next year or two because we’re going to have, maybe we’re going to start a family, might have some kids or we’re just trying to look to expand.
Am I in a position to refinance if I’m just about to look at making a move in the next year or two? Probably not. You do have to take a moment to stop and think about what’s about to happen. Just because interest rates are lower and it sounds like I can lower my payment and if I don’t give myself enough time, I can’t hit that break-even. And I think Dina, you have an example for later in life, you even maybe…
This is the other side of your story. You’re working with the first-time homebuyers. Now I’ll be talking about people who have, their kids have moved out, they’ve finished paying for college, they’re considering retirement and possibly considering either downsizing or moving to a different state, a warmer state possibly. And they’re not going to be in that home for a long time. Again, you don’t know exactly what that timeline’s going to be, but it might not make sense to go through this process, pay those fees and then not be there long enough to break-even and recuperate that cost.
I think people are oftentimes trying to look for a rule of thumb here. And if I was to give some general guidelines is if you’re going to be somewhere less than five years or five years, it’s probably not a good opportunity for you to refinance. If you’re going to be there for 10 years, it might be, if you’re going to be there for 20 years, it probably is without a doubt.
And that’s also going to depend too on again, how low can you get your rate? That’s obviously plays into your break-even, and if Rick like you said, if you’re planning on moving in the short to mid term, you’re going to have to take a hard look at how much you’re saving and how long you’re going to be staying.
Hey, you’re cheating. You’re jumping ahead to other questions.
Sorry about that. I couldn’t wait.
But you’re absolutely right.
Well, on that note, let’s move ahead. Number three, also very important here. What will it take to qualify for this new mortgage?
This is a full credit application. You’re now going through a credit application, you’re going to have to provide proof of income, possibly tax returns, statements potentially to show that you’ve got liquidity and net worth. It’s a full credit application credit check. And you have to consider where you were when you purchased the home. Your situation might’ve been a little different. You might not have had some car loans or other debt reflected on your credit. You might also be in a position where you’re retired and you don’t have that traditional source of income coming in. And so, you’d have to prove that you’ve got cash flow coming in in order to qualify for this very in-depth application process.
Yeah, absolutely. It may be a good example as a lot of times we’re working with folks in retirement who think about their paychecks that don’t show up each month, they get Social Security and maybe they’re in a fortunate position where they’re now able to exclusively live off their investments and maybe some other smaller fixed income. Well, when you go to the bank and say, “Hey, I want to refinance my house.” And yes, people in retirement can absolutely have mortgages, by the way, in case anybody was wondering, just because you’re retired, especially with interest rates as low as they have been compared to historical rates. Yes, it is okay to be in retirement with a mortgage. So when we’re talking to that person that wants to refinance and it’s still debating in retirement, whether it should be 15 or 30 years, we want to be able to help them qualify.
When they go to the bank, the first thing they want to see is “where’s the money coming from?” So sometimes we have to create that cash flow to show that you have a consistent deposit and that’s just being part of that process to be able to qualify. Sometimes you have to do some advanced thinking before you go to knocking on the door at the bank and saying, “Hey, can you loan me a couple of $100,000 when I don’t have any cash flow showing in my checking account?” Well, even when your mortgage is staying at the same bank, you still need to requalify. So just because you’re staying in provider, you’re starting from scratch.
And I think it’s important to mention here, too, that the lender that you choose to go with is also really important. If your situation is very straight-forward, very simple, you’re still working, you’ve got income, you could probably go with any lender. But if you’re in that situation as Rick mentioned, it’s a little more unique. It needs to be a more personalized approach. You might want to consider going more to a relationship-based bank, somebody that you already know. It could be a credit union. You might be a little more limited with who you can find that financing through.
Sure. Yeah. And will definitely we’ll touch on that whole concept a little bit later in the episode, as well as another consideration, but definitely something good to consider there. So, number four, Rick, I know this one is near and dear to your heart. That is: What term should you opt for?
I think Dina and I will both… We come from slightly different viewpoints on this and that’s actually makes our conversations more fun, is that when you’re thinking about a 30-year or a 15-year, which are traditionally the two timeframes, you can absolutely get different timeframes than that, but let’s just use those to unpack this concept. Well, besides the time that it would take for you to pay down this mortgage, it also comes with some other differences, which include costs and interest rates. Now think about if I’m borrowing money from a financial institution. If I borrow it for 15 years, I create less risk for them with the idea that I’m going to be able to pay it back faster.
So that usually comes with a lower interest rate. So you may be looking at the difference on a 15-year of 3% versus a 30-year of 3.5%. Well, right there off the bat, I say 3% is better. I want to pay less. Well with that timeframe difference even though interest rate’s lower, I have a higher monthly payment which requires me on a month-in-and-month-out basis to make that payment including any of the other wrappings that I have with it, like insurance and taxes. And over time, that can be difficult especially if we hit some speed bumps in our planning. The 30-year, as we think about it, yes, it will over its lifetime cost us some more in interest. But if we look at the monthly payment it would be less. It may actually afford us to be able to do some other things with that money. Now, as long as they don’t take that extra money on the 30-year that I’m not paying because I’ve got this longer timeframe to pay it.
And so my monthly payment is less and I don’t take it and go on vacation each year or buy the newer and more expensive car, but I actually turn around and I save it. There’s one thing that you do get as potential advantage with a 30-year especially since yup… The mortgage may be over 30 years but the good thing is that I actually have been saving on the side and I have this big investment account that now is compounding and continuing to grow over my lifetime, which last I checked, no matter how hard or how much I dug around the house, I can’t uncover the cash that I’ve buried in my house. It’s sometimes nice to make sure that I have some cash on the side invested in a side account so that I can ensure that I can make that monthly mortgage payment while I have it.
So this question really gets to the heart of the fact that there are some investment implications as well with what term you opt for. Rick talked about interest rate versus maybe what you could get investing that money instead, right?
Yeah. The investing part of it is if you’re going to be someone who takes your extra money, because remember if I’m paying $2,000 a month on my 15-year mortgage and paying $1,500 a month on my 30-year mortgage, and I take the extra $500 that I have each month and invest than I earn, I put it in cash well, I’m not going to be able to keep up with my 3.5% interest rate. But if I invested in my investment account for longer-term appreciation, I’m able to earn, I don’t know, 3.6%, or maybe even way better, let’s say 6%, where we’re really aggressive in everything goes well in the world and we’re at 10% anyways. Obviously, the bigger return we get, the better outcome, but I would always argue that Dina, this is where you and I may have some pushback or a different thought is, I’m very comfortable leveraging myself on my house because I know I just have a monthly payment, so I can use that extra money to invest.
But on the flip side of that is, I’ve put very little into my house. So when I look at what my house represents for me, I have put in, let’s say 25 or 30% of the house value, but when the house value goes up 10%, I don’t only get it on what I’ve put it in. I get it on the actual house value. So let’s say, just as a quick example, I think this will help it hit home a little bit more is that if I have a $500,000 house and I have a $100,000 in it, and the house value goes up 10%. Well, now I have a $550,000 house that I only had $100,000 in. I just made a $100,000 on my $50,000 investment while I had the ability to save over on the side.
Now, this is for fortunate people. This is for people who have enough cash flow to meet these obligations and still do the thing that most people would love to do. And that’s save in addition. So I know this is a perfect scenario that I’m talking about, but don’t miss it. Don’t think that my goal is to always pay off my loans immediately.
And I’ve got access to these low loans. And if you are lucky enough, you may even be able to deduct this interest on your mortgage. Tax laws are unique to each person, but anyway, Dina go ahead, please.
Yeah, so I think Rick, the reason why we have maybe different perspectives on this. I agree with everything you you’re saying. However, I think debt is a psychological concept. And for some people they’re very comfortable looking at it the same way that you are, that they’re leveraging that real estate and they’re building up their investment accounts at the same time, while other people are not comfortable with debt and the objective is to get it paid off as fast as possible. And that can sometimes cloud the idea of also trying to balance out other investment opportunities. From my perspective, it is balancing act and you can get the best of both worlds if you just balance it out properly.
So in a situation like this where somebody did refinance and decided to take the 30-year term, which is, I think what we would all recommend. It gives a lot more flexibility if they do have excess cash flow like let’s say they got a bonus, or they got an inheritance. I don’t think that it’s unwise to put a little bit of that towards the mortgage. It just pays it off a little bit faster, but you also have to balance and make sure that you are building your retirement savings, you are setting money aside for any other goals that you might have and not just putting it all into the mortgage.
Right. And this is where the art and science part of this comes in. You can run the numbers on a spreadsheet and it might turn out that the 30-year looks better, right?
My spreadsheets always show that investing is better.
I have seen them but Dina, like you said, debt is a psychological concept. And some folks are just more comfortable getting this paid off as soon as possible. There’s no one right answer. That’s why it’s personal finance. We’re going to help you think through it for your individual situation. So that’s a really good one, guys. I think let’s transition to the final question.
Number five, at this point, you’ve gone through the first four questions. Let’s say you’ve decided you want to go ahead and refinance your mortgage. You’ve got your rate, the fees, your break-even, you know what term you want. Okay, now the rubber’s going to meet the road. How do you complete the refinance process?
Yes, so where I’m going to start off with this is… Now I go to this bank, this imaginary bank that we’ve been talking about, and I’m going to ask for money. Well, what does that actually mean? People think of their bank, they may think of the big national bank that they’ve been using for the last 20 years, but many cases, it’s not. You have to think, well, let’s hear, I’ll pinpoint it down to, there are those big national banks, but you’re probably going to be better served, maybe contacting that regional bank. That’s a little bit closer to home first, who has a vested interest in the community and the place that you live. Another option would be to consider going online. Use your junky email account to contact these companies to make sure that after you find out your initial contact on what’s going to be in it for your potential loan or for your refinance mortgage, that you can survive the bombardment of advertisements that you get afterwards.
That is a fair warning. The other one is if you’re in a fortunate situation where you have quite a bit of financial resources, you may be looking at some of the private banks or private client services, which could give you access to some of these better loans. It’s really going to be unique to you, but don’t just take the first offer, I think is my biggest point. Yep.
You should shop around. And if you don’t know who to talk to as well, please do contact your adviser. We have a lot of contacts and we’ve worked with them directly too, so don’t hesitate to reach out.
Yeah, that’s a very good point, Dina. And really, if we didn’t say it enough throughout this is that each one of these decisions in each one of these questions that we’ve gone over are the conversations that we’re having with our clients. Don’t go this alone. Take the time to build up your checklist of questions that you need to be asking with your adviser, with us. This is what we’re doing here at Adviser Investments working with our clients.
It’s like the song says, “you better shop around.” Let’s just say that. I’m going to recap the five questions, because I think it’s important to do that at this point. So again, number one, what are the fees? Number two, how long are you staying or planning on staying in your current home? Number three, what will it take to qualify for this new mortgage? Number four, what term are you going to opt for? And finally, how do you execute this?
These probably aren’t exhaustive. There are other things to consider, but we think that these were really the five most important questions to consider when thinking about whether refinancing is a good decision for you. This has been a really great conversation. I know we’ve wanted to do this one and I’m glad that we did. It’s been on the minds of a lot of people out there. Rick and Dina, what were some of your big takeaways from the conversation? Dina, please.
I think every person’s situation is unique. Every individual they’re coming from a different place. So I think the important thing is to do the research, look at your needs, ask yourself these five questions, make sure that it’s suitable for you. And then if it is then, go for it. Don’t overthink it after that. But I think the biggest thing is make sure that you are saving by going through the refinance process.
Yeah. I would agree with you. I think that is definitely one of my biggest takeaways as well. And the other is, I already said it, but don’t go it alone. Use your resources. You should have someone that you can speak with, an unbiased resource that can get you in contact with the right folks that can help you with the refinancing process. And also, maybe more importantly, fit it into your plan, understand how these changes will impact decisions that you get to make, or maybe don’t get to make in the future. It would be the ones that you get to make. Use your planning opportunity to make that happen.
And I would just say, I mentioned it at the beginning, but just because your neighbor refinanced doesn’t mean it’s the best decision for you. We talk about that with investing, with a whole slate of different financial planning topics. So make sure to talk to us, your adviser, Rick, like you said, so just make sure that it’s the best decision for you moving forward. So this has been Rick Winters, Dina Milne and Andrew Busa from Adviser Investments thanking you for listening to The Adviser You Can Talk To Podcast. If you enjoyed this conversation please subscribe, review our show and you can always check us out at www.adviserinvestments.com/podcasts. Your feedback really is always welcome. If you have any questions or topics that you’d like us to explore, please e-mail us at firstname.lastname@example.org. Thanks for listening.
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