As we have recently written, global equity markets are attempting to price in the uncertain economic impact of the new strain of the coronavirus. With the current volatility, many investors are focused on the daily changes in their asset values. Meanwhile, there is another component to your overall net worth that deserves some attention, and that is your outstanding debt balance.
The good news about volatile equity markets like we are currently experiencing is that there is an inevitable flight to safety that leads to investors seeking certainty in the bond market. The selling that happens in the equity markets generally benefits bond investors who find their bonds suddenly more valuable when market interest rates decline. On Tuesday, March 3rd, 2020, the yield on the 10-Year Treasury note dropped below 1.0% for the first time and now stands at 0.71%. We have also seen the Federal Reserve step in to provide stimulus in the form of a lower Fed Funds rate. Like we saw with the financial recession of 2008, we are seeing once again why it is beneficial for most long-term investors to have a portion of their overall portfolios allocated to fixed-income investments. With this drop in yields, mortgage rates have similarly declined. Given what is happening with interest rates, now may be a great time to reassess your overall debt position and take advantage of the return to historically-low interest rates.
It is important to note, though, that just because rates have fallen, it is not a given that you should refinance your mortgage. Each homeowner’s unique circumstance and longer-term plans should be factored into the refinance decision. There are questions you should ask yourself in making that final determination. Here are some thoughts to consider before refinancing your mortgage.
How much will it cost to refinance my mortgage?
While it is great to save money each month on lower interest payments, a refinance does come with some costs. These costs are typically paid at closing and are payments made to those involved in your refinance—like an appraiser, a closing attorney and administrative staff handling your paperwork. As an example, let’s say that a refinance is going to save you $500 per month in principal and interest payments, but you have to pay $5,000 in closing costs to refinance your current mortgage. Within the first year, you will save more in debt payments ($6,000) than the cost of the refinance ($5,000). In this example, the payback period is less than one year, and it is likely wise to move forward with the refinance.
How long are you going to own your mortgaged home?
Because there is a period in which it isn’t wise to pay closing costs with a refinance, you should consider how long you are going to stay in your home. If there is a chance that you will sell your home before that payback point is reached, you may be better off continuing to pay the higher interest rate on your existing mortgage. You may think that you are in your “forever home,” but in the U.S., homes are owned for 5-7 years on average; therefore, it is important to consider whether or not you will meet that payback point.
Do you have a higher-interest rate second mortgage that can be rolled into your refinance?
Many homeowners may find themselves in a situation where they have a first mortgage with a fixed interest rate that is competitive compared to today’s market, but they may also have a second mortgage in the form of a Home Equity Line of Credit that has a higher, variable rate of interest. In this case, it may make sense to consolidate these two mortgages into one primary mortgage that has a lower, fixed rate of interest.
Are you willing to increase the term of your mortgage indebtedness?
As an example, if you have four years remaining on a 15-year mortgage, it likely would not make sense to refinance with another 15-year mortgage because you are at a point where most of your monthly principal and interest payments are going toward principal reduction. In this scenario, it would not be ideal to refinance to a longer-term mortgage because you would become indebted longer, and your monthly payments would revert to going more heavily toward interest than principal.
As you consider your personal situation and next steps, know that Warren Averett Asset Management is here to help you. Equity markets are volatile and so are the current interest rate markets. Those who originate mortgage loans are reporting to us that they are quite busy with helping homeowners refinance. While we do not originate mortgages, we can help you determine whether or not refinancing might make sense for your overall financial plan. If you have questions, or if you would like to review your financial situation, click here to contact one of our advisors.
Heath Echols serves as a Member and Senior Client Consultant with Warren Averett Asset Management. Click here to learn more about him or to reach out to him directly.