Low Mortgage Rates Hard to Love

The only thing financially savvy homeowners and real estate investors love more than low mortgage rates is a good solid recession. Thanks to the microscopic coronavirus, we may very well get both in the next few months. Mortgage rates are already scraping all-time lows and the economy is suddenly looking more than a bit wobbly.

With mortgage rates in the headlines nearly every day, you might be wondering why you’re still sitting on the sidelines. Well, there are plenty of good reasons why staying the course with your existing mortgage might still be your best bet. It’s not always easy to take advantage of even historically-low mortgage rates.

Here are a few reasons why low mortgage rates are sometimes hard to love…

You Still Need to Qualify

Low mortgage rates and hard economic times often go hand in hand. No less than 3 million Americans filed for unemployment benefits last week alone, which begs the question, can you still qualify for the full mortgage loan amount you need to refinance?

Banks will be scrutinizing income and asking for copious amounts of back up documentation in order to properly qualify you for the loan you’re requesting. Depending on how the economic shutdown impacts your paycheck, this might present serious challenges in the weeks and months ahead.

While retirement accounts can often be counted toward reserve requirements, the coronavirus stock market crash has cut the value of many retirement accounts by 30% or more. If you don’t have other sources of reserves to back you up on paper, mortgage lenders may balk.

Whatever your income situation, you’ll need to carefully assess whether you’ll still meet key qualification ratios and reserve requirements before getting too far along in the refinancing process.

You’ll Need an Appraisal Too

Right now, appraisals are hard to come by because a lot of appraisers simply won’t venture out to inspect the property. Some banks will proceed nonetheless, on the basis of an electronic or algorithmic appraisal.

The problem is that it’s not exactly clear what the variables in the appraisal model should be right now. The economic situation is evolving so fast that most appraiser’s valuation models probably won’t be very reliable in the short term. Some appraisers may choose to whack values based on lackluster expectations for the country’s economic performance over the next few years.

If you’re refinancing an investment property instead of your primary home, your appraisal will be heavily dependent on your in-place and market rents. Are your tenants even paying rent right now? If they’ve lost their jobs due to the coronavirus situation and are falling behind, your appraiser might have reason to knock your rents down just to be safe.

Even in good times, appraisals can be a bit of a wild card. In times like these, they’re a total crapshoot.

Maybe Your Existing Rate is Already Low

The thing about today’s all-time low mortgage rates is that they were preceded by other mortgage rates that were also really low. A lot of borrowers have already refinanced! If you’re lucky enough to have a good rate already, it may not be worth the extra fees and considerable hassle to refinance again.

The math is interesting. If you refinance a 30-year fixed $300,000 loan that was originated a year ago at 4.5% to a new $295,160 loan at 4.0%, your payment goes down by $111/mo. You’ll save $1,331/yr, but even then it may take you 2-3 years to break even once you account for appraisal costs and other refinancing fees. Factor in your time at $50-100/hr and you’re well into year four before you’re back in the black.

That begs the question, how sure are you that you’ll still own this asset in four years? A lot has changed in four weeks. Just think what can happen in four years!

Variable Rates Are Terrible Right Now

Another reason to think twice about refinancing now is that some quotes on adjustable rate mortgages (ARM) are a joke. Unless your bank happens to be quoting you an ARM rate that’s lower than their fixed options, there’s basically no reason to even consider an ARM right now. If you thought maybe you could swap out a recently inked 30-year fixed for an even lower ARM, it’s probably not in the cards at the moment.

The 5-year, 7-year, and 10-year ARM rates that many banks are quoting today are in many instances higher than longer-term mortgage products like the 15 and 30-year fixed. That makes no sense and it’s best to simply stay away from these upside down price quotes.

Points & Fees Extend the Payback Period

Given the high current demand for refinances, most banks are requiring points and other significant fees. These act as a check on borrowers who might otherwise refinance to gain even the slightest rate improvement.

Returning to our example above, paying just one point on a $295,160 refinance loan amounts to a $2,951 up front fee. That cash outlay alone will wipe out more than two years of mortgage payment savings when moving from a 4.5% interest rate to a 4% rate on a 30-year fixed mortgage.

The key point here is that whenever you’re comparing mortgage refinancing rates you’ll want to pay close attention to the fees. If they’re not obvious from the rate quote, just ask. Lenders will generally have a set fee schedule available and you can sometimes get various fees waved or reduced if you push back. The most significant refinancing fees usually include points, appraisal, loan origination, and lender’s title insurance. Loan origination fees are often the ones that can most easily be reduced or waived.

Make sure you include all the expected fees in your calculations before jumping at the opportunity to improve your rate by anything less than a full percentage point. If there’s a decent chance you’ll be selling the property in the next five years, you may think twice about refinancing once you run a proper payback period analysis.

You’ll Be Making Payments Forever

One overlooked reality of refinancing is that you’re basically starting over in terms of the timeline. If you’ve been paying off your existing loan for the past five years, you’re on track to be debt free in 25 years. If you refinance now with a new 30-year fixed, you might lower your monthly payment, but you’re also adding five years to your target date to retire the loan.

Amortization math is a little bit squirrelly but one way to maintain your expected payoff date and enjoy the benefits of a lower rate is to simply kick in a little extra principal each month. Using the same example discussed above, your monthly payment on the original $300,000 loan goes from $1,520 to $1,409 on the new refinance loan. Instead of pocketing the savings each month, another option is to keep making the same $1,520 payment under the new loan. The extra $111/mo of principal each month means you’ll pay off the new loan nearly three years earlier than you would have paid off the old one!

Debt Isn’t Always Your Best Friend

For many investors, the primary motivating factor behind a refinance is often to pull out cash for a new deal. When values are on the rise, your debt to equity ratio falls and it’s easy to start treating your properties as piggy banks. What’s often missed with this approach is the safety that comes with deleveraging.

Rising property values and mortgage principal payments both work to lower your leverage and strengthen your ability to withstand shocks. We now know that shocks to the system can come from all corners, including public health. Debt can be a beautiful thing when deployed wisely but it’s a saw-toothed boomerang in tough times.

If your primary reason for refinancing is to pull cash out for a new leveraged investment, it’s worth running a few scenarios to make sure you’re comfortable with your new risk profile. Can you comfortably cover all resulting debt obligations after a 10% hit to rents? How about a 20-30% hit from a once-a-century pandemic?

Still, Maybe You Should Refinance!

Once you’ve slogged your way through the roadblocks and challenges discussed above, refinancing might absolutely still be the right move for you. If you can reduce your payment, access untapped equity, or pay your loan off faster without getting buried in fees and time-consuming paperwork, it just might work out brilliantly.