“Should we refinance now, or wait for lower rates?”

Good question, very good question! Unfortunately, there is no easy answer. Human nature sometimes drives us to the brink, causes us to push the envelope a bit too far all in an effort to claim the proverbial grand prize…..whatever that might be. In this case, the proverbial grand prize is the bottom of the interest rate market. After all, wouldn’t it be grand to be able to proclaim to our friends and neighbors that we refinanced when interest rates were at their lowest? However, waiting too long could be disastrous to your health, your financial health.

So, what should we do? How should we proceed? Let’s try to help you make that decision as objectively as possible. To do this we need to consider the cost/benefit factor, risk/reward factor or what ever you prefer to call it. Bottom line is we need to determine how we might gain from our action versus how we might lose from our “lack” of action.

First, let’s try and understand where current interest rates are relative to historical levels. In short, we hit a bottom in 2003 when 30 year, no cost, conforming loans were at 5.25%. Subsequent to that bottom, rates peeked for a comparable loan at or slightly above 7.00%. To put this into perspective, let’s look at a loan amount of $400,000….a 5.25% rate would create a monthly payment of $2,208.81 while a 7.00% rate would create payment of $2,661.21…..nearly a 20% differential.

In the last two months we have seen a precipitous decline in interest rates to a current level of approximately 5.75%. While we dislike using “approximately”, it is only fare to do so since the interest rate market is naturally volatile and extremely volatile when rates begin to flirt with all time lows, as they are now. In January, we saw rates range from a low of 5.375% (1/14 before the Fed. lowered rates) to 6.125% (after the Fed. lowered twice)…..imagine that! Again, putting this into perspective, a loan amount of $400,000 with a rate of 5.375% creates a monthly payment of $2,239.88 while a rate of 6.125% creates a payment of $2,430.44……nearly a 10% differential.

While your situation might be a bit different, let’s assume for illustrative purposes that you currently have a $400,000 mortgage with a 6.125% interest rate. Should you wait for interest rates to return to the 5.375% or even lower before you refinance? Let’s look at your options in terms of cost/benefit:

• If you wait for lower rates and they come to fruition, lets say in five months, the cost of waiting can best be quantified by the difference in monthly payment between the 6.125% rate and the 5.375% rate for a period of five months ($2,430.44 - $2,239.88 = $190.56/mo. x 5mos. = $952.80.). The benefit in this case would be very substantial, a $190.56 monthly savings for 30 years…..$68,601.60. In this case, the cost/benefit scenario would look like this $952.80 (cost) vs. $68,601.60 (benefit)…...Clearly, a no brainer!

• Let’s say while you are waiting for rates to go down, they reverse the trend before touching the 5.375% and then return to 6.125% or even higher. Your benefit here is easy to calculate…..it is zero! The cost of this action or lack of action is not so easy to calculate, but would relate to not refinancing at a lower rate somewhere between 6.125% and 5.375%. For giggles, let’s assume that the rate dropped to 5.75% then returned to 6.125% or higher. Now we can calculate the cost of waiting and that would relate to the lost opportunity of securing a rate of 5.75%. A 5.75% rate would have a monthly payment of $2,334.29 which is $96.15 less than the monthly payment at 6.125%. The cost then becomes the lost opportunity of $96.15 per month for 360 months or $34,614.00……In this case, the cost/benefit scenario would look like this $34,614.00 (cost) vs. zero (benefit). ….. No brainer? …….You decide.

  • Let’s say that while you are waiting for rates to drop to the 5.375% level, you take advantage of the available 5.75%. In this case you have now locked in the benefit of the monthly payment savings of $96.15 for a total benefit of $34,614.00. And guess what? You can never lose that benefit and you can still put yourself in position to wait, hope and even pray for rates to continue downward to 5.375% or even lower…...No brainer!
  

Just a couple of things before closing:

1. You might think that the $96.15 is not very significant and as such you might still choose to wait for a more significant benefit. Two things to consider here:

• If your insurance agent called you and offered to pay your homeowners insurance for the next 30 years, which might equal $96.15 per month, would you let him?........I think you might.
  
• Here we would suggest that you take the 5.75% refinance but continue to make your previous payment based on the 6.125%...the result would be to shorten the payoff of your mortgage by approximately 3 years.

2. Lastly, Preferred Financial is the company that brought the “no cost” loan to the marketplace in the early 90’s. We are passionate about this concept and when we can deliver a refinancing benefit to you without you having to pay thousands of dollars in fees and points and still be in position to take advantage of even lower rates……..guess what?..........no brainer.

Thanks for your attention. Please give me a call with any questions you might have.

Regards,

Anthony Bilich