There are a lot of misconceptions relating to whether it makes financial sense to refinance if you are only dropping your rate by one-half of one percent. I have often heard customers say that they “don’t think it’s worth it unless they can drop their interest rate by a full percentage point”, which is very rarely the case! It was different before the crash of the mid 2000s: it was a lot more expensive to refi - upwards of two percentage points (plus closing costs) higher. On a $500k loan amount, it was very common for a homeowner to pay $10k in lender fees, and then also $3-4k in third party fees, making it $13-14k; additionally, there could be a prepayment penalty on their previous loan (upwards of 2%), so you’re talking about $20-25k gone, right away!
Those days are behind us. Since the housing crash, the market is much more competitive, and mortgage-backed securities are more liquid, safer, and in-demand. Homeowners can shop for the best deals now. Oftentimes, they can get a lower rate with $0 in closing costs. Most lenders will have $0 closing cost options. Paying no closing costs does not mean that the lender or loan officer isn’t getting paid, they’re just getting paid through the interest rate that the borrower pays. As opposed to paying fees at the time of loan closings or having them rolled into the loan with a higher loan amount, the borrower simply takes a slightly higher rate in exchange for not paying fees. This way isn’t better or worse, there are just different ways you can finance depending on your goals.
Now, on to a breakdown of some common scenarios that warrant a refi these days...
The rate factor
Financially speaking, if you’re doing a $0 closing cost loan where you’re not paying any fees, and you’re able to drop the rate at all, it most likely makes financial sense. A lot of times, people think they have to start over on a 30-year fixed if they refinance again, but they don’t. Unlike before the market crashed, there are no prepayment penalties on 99% of loans. That means that you can refinance at a lower rate with $0 closing costs, keep paying what you were paying before, speed up your term and not lose any time! I very often see homeowners with a $400-500k loan amount at a 4.375% now, and I’m able to show them a 3.875% with absolutely $0 costs. Oftentimes they are hesitant until I show them a “matched payment” option.
Hypothetically, if we switched that $500k loan to a 3.875%, and they kept paying what they are paying now, they’d apply more towards interest and reducing compound interest at a quicker pace. Doing matched payment is going to save them over $100k in interest over the course of the term! So again, the mindset that they had to drop a full percentage point for it to be worth it just isn’t the case. Oftentimes, we’re refinancing repeat clients for as little as one-eighth of a point. Typically, we encourage a client to drop .25% prior to refinancing again. Depending on the loan amount’s size, a quarter-percent or more is a good rule of thumb, if they can do it at zero cost.
Credit card bailout
There are other benefits besides just dropping interest rates on a refinance. Thinking outside of simple rate and term refinance, they might also look for cash out, and debt consolidation. It can make perfect sense to refinance (when homeowners don’t think that it does) if they’re carrying $40-$50k in credit card debt, making minimum payments every month for a considerable amount of time. What they might not know is that they can wrap the $40-50k of credit card debt into their loan and pay it off when they can, with no prepayment penalty!
After all, credit card interest much higher than mortgage interest, and mortgage interest is tax deductible too. It will also boost your credit substantially to get your credit cards paid.
Out of an ARM
It also makes sense to refinance when you’re in an adjustable rate mortgage (ARM). The LIBOR index (also known as the London Interbank Offer Rate) has shot up substantially - as high as 3.25% - which would have made rates on a lot of ARMs 5.5%, and after Brexit, the LIBOR shot up further. It has come down a lot over the past year, to around 4.25% adjustable rates. So would it make sense to take a rate of an adjustable rate mortgage at 4.25% in today's market? Probably not. Why would anyone get a 4.25% 30-year adjustable rate mortgage when they can get a 30-year fixed rate at 3.625% or 3.75%? Any time you can refinance out of an adjustable rate mortgage into a fixed rate for a lower rate, it almost always makes sense!
These are a few examples of when it might make sense for homeowners to really consider refinancing. As always, it’s very important to be comfortable asking a reputable loan officer for good advice. You won't regret doing your due diligence to get the best rate possible! To check rates any time without speaking to a loan officer, feel free to check out our live quote generator, or feel free to give Prospect Financial Group a call at 858-605-0952!
Prospect Financial Group
948 Garnet Avenue
San Diego, CA 92109
NMLS: 349089 | BRE: 01837707
Jason Vondrak has been in the mortgage industry since 2004 and co-founded the mortgage brokerage Prospect Financial Group in 2006 in San Diego, California. Today he serves as President and CEO of Prospect Financial Group and the president and founder of Prospect Property Group, a real estate development company, established in 2012.
"I've had the privilege to serve in an industry that exists to ensure homeownership remains among the top priorities of government and citizens alike. Over the years, it has been a pleasure working alongside homeowners, real estate professionals, and business associates combining efforts and teaming up to help homeowners realize the dream of home ownership."
We've been helping customers afford the home of their dreams for many years and we love what we do.
Company NMLS: 365482
948 Garnet Ave
San Diego, California 92109
Phone: (858) 605-0952