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.