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Mortgage rates are at record lows — should clients refinance?

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As the coronavirus pandemic persists, mortgage rates have tumbled to their lowest-ever levels. With that drop comes an opportunity for homeowners: refinancing.

“When the news came out that the 30-year mortgage hit an historic low [this year], we sent an alert to all our clients with active mortgages offering to discuss refinancing,” Liz Miller, president of Summit Place Financial Advisors in Summit, New Jersey, said via email.

“Even clients that may have refinanced in the last 18 months might now benefit from looking at a new refinance,” she wrote.

15- or 30-year rate?

Other advisors are seizing the opportunity to serve clients. But even with mortgage rates dropping to around 3% today (down from their all-time high of 18% in 1981), financial planners are of different minds about when refinancing is the right move. In some cases, it may not be, depending on clients’ long-term financial goals. Instead, planners are suggesting clients look at other options and creative solutions.

Some are recommending clients shorten the duration of their fixed-rate mortgages. “Shortening to a 15-year does not normally increase cash flow during the payment period, but will increase cash flow on the payoff of the mortgage debt sooner. This saves significantly on the cost of interest over the life of the mortgage,” says Greg Spears, COO of FCS Wealth Management in Leawood, Kansas.

“We’re seeing a lot of refinances, both for primary residences and second homes,” Spears says. “Many of our clients are … moving from the 30-year mortgage down to a 15-year.”

This choice can be risky, however. The higher payments that come with a 15-year mortgage may become a burden if a client loses his or her job. A 15-year monthly payment can be as much as 65% more than a 30-year monthly payment, according to advisor Paul Roy IV of Wells Fargo Advisors in Boston.

“I’ve had many clients who want to go to a 15-year from a 30-year, and I discourage that,” says Darla Kashian, an advisor with RBC in Minneapolis. “Instead, I encourage them to go with the 30-year, and make an extra payment a year. Then they know if they can’t sustain that payment, they can always drop to the stated payment on the 30-year.”

Starter home or retirement home?

The decision about whether to refinance hinges on clients’ individual financial objectives.

“If your client plans to be in their home for many years to come, go with the fixed rate,” says Roy. “If they’ve just bought their first home, and know they’ll need to upgrade in a year or two when they have their first kid, then a variable rate might be for them.”

If an older client is living in the home in which they plan to retire, refinancing may be worth the closing costs and interest in the long run, Kashian says. However, it may not be worth the hassle and costs if the client plans to, for example, retire to another state and sell their current home.

Calculating true costs

Though the ability to refinance at historically low rates may be exciting for clients, they’re often not aware of certain pitfalls.

The first is that a refinance is not free. There are closing costs as well as interest payments that need to be calculated to a break-even point to ensure it’s worth the investment. Closing costs can range between 3% to 6% of the loan. There are also fees for appraisals, credit reports, applications, and filings. “Depending on how long a client is going to stay in the home, these costs can make the mortgage more costly than the potential cost savings,” says Kashian.

These should all be part of calculating a client’s break-even point. “If they’re refinancing a $500,000 mortgage, and closing costs are 3% ($15,000), how long should they live in the home to make it worthwhile?” says Kashian. “Are they going to pay the closing costs upfront or roll them into the loan? If the plan is to pay it upfront, what is their opportunity cost of tying up that cash?”

Another concern is the likelihood of having to cancel an existing home equity line of credit in order to refinance a primary mortgage, says Bruce Colin, owner of Bruce Colin Wealth Management in Rancho Palos Verde, California, via email.

“A HELOC represents an important safety net, particularly in the midst of the current pandemic and its challenges,” Colin adds. “I have strongly encouraged clients to ask their mortgage brokers about the likelihood of being able to obtain a new home equity line once a refinancing occurs. If that likelihood is low, then they must weigh the trade off between having a lower monthly payment with the potential absence of an important safety net.”

For first-time home-buying clients, Brian Ellenbecker, a financial planner at Shakespeare Wealth Management in Pewaukee, Wisconsin, cautions restraint.

“Low rates can tempt individuals to stretch on the purchase price, as they can now potentially afford a larger home,” Ellenbecker says via email. “While they may be able to afford the monthly loan payment, it's important to realize that more expensive or larger homes come with larger ongoing maintenance costs — many of which pop up unexpectedly. It's important to factor these costs into the equation when determining if they can really afford that more expensive home.”

That sentiment is echoed by other advisors. “We always discourage our clients from using low rates for the sake of funding anything they would otherwise not be able to afford for themselves over a reasonable time frame,” Miller says.

However, Roy points out one example of how clients could use the low rates to their advantage. Say a client locks in a mortgage rate under 3% now, and interest rates go up in the next five years. If they then open a certificate of deposit at a rate of 5%, they could be making more money with their CD than what they are paying on their mortgage. “Their mortgage becomes an asset down the road because of its positive leverage,” Roy explains.

Advisors should also ask clients how they plan to use the extra cash flow from refinancing. Kashian says that a home addition or a bathroom remodel would be better than a trip to Cancun or tuition payments.

“The home is a tool in a basket of considerations to think about,” Kashian says.

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