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Time and Again: Serial Mortgage Refinancing

Written by Nickel - 16 Comments

I recently ran across an interesting story on CNBC about “serial refinancing” – the practice of refinancing your mortgage time after time as rates improve. On the surface, this makes perfect sense. If you can drive down your rate without incurring additional costs, why not?

And yes, you can refinance without paying any closing costs. To do this, you effectively sell points – i.e., you accept a higher than market rate on your mortgage in return for cash to cover the closing costs. As long as this rate is lower than your current rate, you can come out ahead.

This renewed interest in refinancing has been driven by a recent drop in mortgage rates to within 0.25% of last summer’s 50 year lows. Of course, you can only refinance if you currently owe less than your home is worth, and nearly 11M homeowners are currently underwater.

With that as a backdrop, here’s a link to the video. I tried embedding it here, but the embed code doesn’t seem to work – sorry. Also note that it’s a Flash video, so it may not work on certain mobile devices.

In case you’re in a hurry, here are some of the more salient points:

For starters, they interviewed an older couple that has refinanced their mortgage four times in the past four years, ultimately cutting their interest rate “nearly in half.” Of course, it was later acknowledged that their most recent round of refinancing involved switching from a fixed rate loan to an adjustable rate mortgage (ARM), so this is a bit of an apples-and-oranges comparison.

Speaking of ARMs… They also interviewed Keith Gumbinger of HSH.com, who argued that ARMs are a good choice for many homeowners because they come with a significantly lower interest rates, such that you can save a ton of money before the rate starts adjusting.

While I agree that ARMs can be a reasonable choice in certain circumstances, you also have to keep in mind the downside risks. When taking out an ARM, you’re essentially betting that interest rates will stay low (such that you can refinance again in the future) or that you’ll move before your rate starts adjusting.

Yes, it’s true that the average homeowner owns their home for just eight years, and that the spread between ARM and fixed rates is the highest that it’s been in eight years, but… You also have to look at recent history and realize that the market might move against you such that you’ll be unable to sell or refinance when you need to.

Another risk of ARMs is that they allow people to buy more house than they can truly afford. In fact, it was just this sort of “creative” financing that got us into our current mess, so be very careful. If you can save enough money to make it worth the risk, then go for an ARM. But if you’re just using that lower payment to justify borrowing more than you can afford, then think twice.

Finally, I found the statistics on the percentage of homeowners using ARMs to quite interesting. Back in 2007, when our ARMs made up 18% of the mortgage market. In 2009, when credit markets were at their tightest, ARMs made up just 1.5% of the mortgage market. Since then, ARMs have made a bit of a comeback, and currently account for 6.5% of the mortgage market.

Should you refinance?

So… Should you refinance? And if so, which type of mortgage should you get? As I noted above, refinancing your mortgage can be a great way to save money, but you also need to keep in mind that you effectively “reset the clock” when you refinance.

For example, let’s say that you’re currently 5 years into a 30 year, fixed rate mortgage. If you refinance into another 30 year mortgage, you’re now 30 years away from paying off your mortgage instead of just 25 years. In that case, you can (and should) consider making larger than required payments to pay off your mortgage ahead of schedule.

Another possibility would be to refinance into a shorter term, dropping from (say) 30 years to 15 years. Yes, your payment will go up due to the shorter amortization period, but the lower rate (both due to current market conditions and to the shorter term) will help to minimize the impact.

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Published on June 10th, 2011
Modified on June 11th, 2011 - 16 Comments
Filed under: Mortgages

About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

16 Responses to “Time and Again: Serial Mortgage Refinancing”

1
Amy Says:
June 10th, 2011 at 12:24 pm
The other big danger that people don’t generally talk about with an ARM is that you might not have enough equity in your house to refinance. That is a huge risk that people generally (before the collapse) didn’t think about.

My sister has a place that she intended to move out of before the end of her ARM, so it didn’t seem like a risk to get one. And she did. But the problem was that the place wouldn’t sell for as much as she owed. So she was stuck with a home that was underwater, she couldn’t refinance without putting serious money into, and she ended up having to rent.

Of course, with rates the way they are, her adjustable is still about the same amount, but it’s a stressful situation to be in.
2
Tara@riceandbeanslife Says:
June 10th, 2011 at 12:24 pm
New reader here. Really enjoyed this post. I find it interesting that ARMS have regained even a small foothold in the mortgage market. We don’t currently have a mortgage but I know many of my friends and family do and I’m not entirely sure they realized they were effectively resetting the clock on their mortgages. I’m curious to know, given how many people got into mortgages they didn’t really understand before the housing market took such a hit, how many people are refinancing without fully understanding. Have you run across this statistic by any chance?
3
No Debt MBA Says:
June 10th, 2011 at 12:54 pm
I didn’t realize you could “sell” points in addition to buying them. Very interesting.
4
Ginger Says:
June 10th, 2011 at 1:10 pm
I just purchased my house in Dec of 2009 using the tax credit. We plan to keep this as a rental but must stay here for another year and half to not pay back the tax credit. If I would “restart” the mortgage by refinancing at the same rate we have now, without paying fees we would do it. We plan to keep this place as rental for quite a few years and paying a little more in interest does not both me, because we would be using the money for the next house.
5
Steve Says:
June 10th, 2011 at 1:36 pm
Restarting the 30 year clock is probably seen as an advantage by many, since your payment goes down. In fact everyone I know who’s refinanced has talked more about the difference in their monthly payment, than they did about the interest rate.
6
ghina Says:
June 10th, 2011 at 1:46 pm
Occassionally Wells Fargo will refinance your home to a lower mortgage with no closing costs, and a streamlined process. Usually for a cost of about .25 pt. It really is effortless but not available to everyone and not all the time. I got one years ago. Rates came down so I asked about it, and it was not available, then magically it was again.

i guess this is a way of keeping people from fleeing WF.

When considering this option, you have to balance the lower rate with the longer period it would take to repay the balance, even if it was no cost.

If you are 10 years in, you are just beginning to bring down the principal balance faster and faster so when you refinance, you get lower payments, but they don’t make a dent in your principal. Which may or may not be important to you.

You could however bring down the payment and continue to make the original payment, thus continuing to bring down your balance and shortening the loan.
7
Evan Says:
June 10th, 2011 at 1:54 pm
I always find our aversion to ARMs interesting since it seems like that is how the rest of the world operates
8
Aryn Says:
June 10th, 2011 at 7:52 pm
We’re heading into our fourth refinance and have been in our home less than two years. So far it’s brought our rate from 5.375 to 4.75. Always from FRM to FRM and with no costs. I ran the numbers, and even with the extended two years, we’re saving about $47,000 in interest over 30 years from our original mortgage. This latest refinance (just 1/8 point drop) will save us $60 a month.

Even if we only stay 10 years, we’ll come out ahead. If we do decide to stay past 10 years, we’ll make some extra payments to pay it off in 30 instead of 32. However, if we were 10 years into our mortgage and planning on staying, I probably wouldn’t refi into a new 30 year mortgage, even if it was free. Instead I would use the rate savings to bump down to a 15-year.
9
TFB Says:
June 10th, 2011 at 9:23 pm
@Evan – A fixed rate mortgage with no prepayment penalty is a unique gift from the US government. People are right to take advantage of it.

I’m also refinancing my mortgage. I will use an ARM this time, with a cash out. When you are within 10 years of paying off the mortgage, ARM is the way to go. If you don’t like the rate when it adjusts, you don’t have to sell or refinance – just pay it off.
10
Ace Says:
June 10th, 2011 at 10:17 pm
Unless you are close to paying off your mortgage or know for certain that you will move in less that five years, only a fool would get an ARM right now. When rates are at (or near) all-time lows, what direction are they likely to head? It is FAR more likely that rates go up in the next five years, simply because there is very little room for them to go down. When rates are so low, why guarantee that you’ll only be able to take advantage of them for 3, 5 or 7 years?

Like I said, unless you know for certain that you will move or pay off your mortgage before the rate adjusts, don’t even think about an ARM.
11
DC Dad Says:
June 11th, 2011 at 7:08 am
Reading some of the comments, it appears that some people really don’t understand that there is no need to lengthen the time to pay off your mortgage, even if you refinance to a new 30 year FRM. There are many amortization calculators available that tell you what your monthly payment needs to be to pay off the mortgage in any time period. You can keep the exact same payoff date by just sending extra principal. But you also have the flexibility to divert that cash to a comparable safe investment if rates rise enough that there are better investments of comparable safety. (Bank CDs, Treasury bonds, etc.)
12
jim Says:
June 11th, 2011 at 11:43 am
A few years ago I took advantage of one of the Wells Fargo free refinance offers like ghina mentions. It was a fairly good deal with very little effort.
13
Bryan Says:
June 11th, 2011 at 5:37 pm
#11 DC DAD – I am in the mortgage business and you will be suprised how many people dont know that concept at all. I advise all clients looking for a shorter term mortgage to take a 30 year fixed and pay the 15 year payment, or show them the amortization for the desired payoff period. If they use the 15 year amortization the loan will be paid off in a littl over 15 years AND if they have a bad month they can go back to making the 30 year payment(which could be hundreds of $ less. Or, as I’ve said in other posts, they can put the difference in an interest bearing account so they always have access to thier money. When the account balance matches the mortgage balance, they can choose whether or not they want to pay it off at that time (rather than put it toward principle every month and losing any future access to those funds)
14
Bryan Says:
June 11th, 2011 at 5:38 pm
@#11 DC DAD – I am in the mortgage business and you will be suprised how many people dont know that concept at all. I advise all clients looking for a shorter term mortgage to take a 30 year fixed and pay the 15 year payment, or show them the amortization for the desired payoff period. If they use the 15 year amortization the loan will be paid off in a littl over 15 years AND if they have a bad month they can go back to making the 30 year payment(which could be hundreds of $ less. Or, as I\\\’ve said in other posts, they can put the difference in an interest bearing account so they always have access to thier money. When the account balance matches the mortgage balance, they can choose whether or not they want to pay it off at that time (rather than put it toward principle every month and losing any future access to those funds)
15
razmaspaz Says:
June 16th, 2011 at 11:35 am
I am unfortunately one of those 11M Americans underwater on a loan. This despite having already paid off 1/3 of the original price of the house. I\\\’m trying right now to take advantage of the lower rates to move to a 15 year mortgage. Sure would be nice, but I don\\\’t think it will happen.
16
CharlieBoy Says:
August 4th, 2011 at 8:11 am
We bought our house in 2008. Our interest rate was 6% fixed, 15 years. We soon refinanced it at 5%, again 15 years fixed, and again last year at 3.75%, 15 years fixed. The payments were so much lower at 3.75% that we started sending a full payment every two weeks. We put our mortgage payment schedule on steroids. Besides, when we bought our house back in 2008, I sensed that the economy and housing prices could not continue to grow forever, and that something stinky was going to hit the fan sooner or later. So I bought much less house that the bank was willing to let me buy, and I also decided to give over 30% down to be able to get a 15-year loan instead of the typical 30-year loan.

Here’s my piece of advice today: Make sure you have enough emergency money saved (CDs or Savings, nOT in the stock market!) to cover AT LEAST 12 months of full expenses, possibly more. Imagine if the next great depression hits, which now is likely to happen because our government this week has voted to continue to live above their means. It’s only a matter of time now before a total collapse. We will see how long before that happens, but do we seriously expect to be able to live above our means forever? How long could you survive if every month you used credit to pay your bills?

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