Real Estate News & Commentary

“Refi-Eligible” Property Owners Reach Record High—But Should You Refinance?

Expertise: Landlording & Rental Properties, Real Estate News & Commentary, Personal Finance, Real Estate Investing Basics
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Property assessment. Wooden house with magnifier and calculator.

A record number of Americans are eligible to refinance their mortgages, according to a recent report by industry analyst Black Knight. (1) With interest rates taking a surprising downward turn in mid-2019, suddenly many loans originated as recently as 2018 now qualify as candidates.

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But does that mean you should refinance, just because you’re eligible?

Here are the facts, and more importantly, the reasons both to consider refinancing and to leave your mortgage as-is.

Record High Refi-Eligible Americans

Among Americans with 30-year mortgages, over half are now paying interest at least 0.75 percent higher than today’s going rate.

Not all of them qualify for a refinance, of course. But a record high number do: 11.7 million Americans have sufficient credit and equity in their property to refinance for a rate at least 0.75 percent under their current interest rate.

And in the second quarter of 2019, untapped equity in U.S. homes also reached a record high of $6.3 trillion ($6,300,000,000,000)—a sum so vast it’s hard to wrap your mind around it.

With interest rates hovering in the mid-3 percent range, borrowers have access to cheaper funding if they want it. But should they take it?

Related: The 3 Major Reasons It Makes Sense to Refinance a Property

Reasons to Refinance

The reasons to refinance are more obvious than the reasons not to, so I won’t belabor the points.

First, of course, you can potentially lower your monthly mortgage payment. For landlords, lower payments help improve their cash flow, and could even push a property with negative cash flow above water—a worthy enough reason to refinance, if the savings is significant.

Second, investors can tap into equity to pull out cash and buy another property. It could be another rental property, or funding for a flip. Or perhaps you’ve been meaning to make some upgrades to your existing properties to justify higher rents and better quality tenants?

While those are all good reasons to pull out equity, many homeowners abuse cash-out refinances. They spend the money on a home renovation that costs more than it adds to the home value, or they go on vacation, or they just spend it on a richer lifestyle.

If you have a detailed plan for how you’ll invest the money from your cash-out refi, then don’t let me stop you. Just make sure you’ve run the numbers inside and out, and you’ve considered the reasons not to refinance, as well.

refinance-mortgage

Reasons to Avoid Refinancing

The reasons not to refinance prove slightly more complex, and dare I say it—mathematical—than the reasons to refinance.

Whip out that trusty calculator and get ready for flashbacks to 10th grade math with Mrs. Peterson. Just kidding, no calculations are required, but you will understand how amortization works within the next few paragraphs!

The Life-of-Loan Costs Go Up

To begin with, you'll have closing costs when you refinance. And not in negligible amounts, either.

Plan on closing costs in the thousands, from appraisal fees to title and legal fees to lender points and junk fees. The points alone often cost thousands, before even getting into the junk fees like "administrative fee" and "processing fee" and "now-we're-just-charging-you-because-we-can fee."

Those closing costs will take years, possibly decades, for you to recover in the form of lower mortgage payments. And that’s if your mortgage payment is lower, which it probably won’t be if you’re pulling cash out.

Start with a simple breakeven horizon calculation. How many years will it take you to break even, for your lower monthly payments to make up for the thousands in closing costs? If your monthly payment is $50 lower, you save $600 per year. If your refinance costs you $3,600 in closing costs, that means a breakeven horizon of six years.

Hardly the slam dunk you were hoping for. And that says nothing of additional interest.

Look up how much total interest you have remaining on your current loan—not your principal balance but the sum of all remaining interest payments.

Next, compare that amount to the total life-of-loan costs (interest and closing costs) of the new loan. If your existing loan will require $100,000 in interest over its remaining life, and your new loan will cost you $160,000 in interest and closing costs, but you’ll only receive $30,000 in cash out, do you think that’s a good deal?

Related: Should I Refinance My Mortgage Even if It Only Saves Me $50/Month?

Amortization Reset

A certain percentage of your monthly mortgage payment goes to interest, and certain percentage goes to paying down your principal balance. But here’s the thing: those percentages change over time.

When you first take out a mortgage, nearly all of your monthly payment goes toward interest, and only a fraction goes toward principal. As the months go by, the proportion of your payment that goes toward principal shifts ever so gradually, with more of each payment going toward principal and less lining the bank’s pockets.

This is precisely why lenders push you to refinance, as soon as you’re “refi-eligible.”

They want to keep you in that initial high-interest phase of the mortgage permanently. To do that, they try to tempt you to refinance, because that restarts your amortization back to Square 1. Thus, the further along the amortization schedule you get, the more they’ll try to tempt you with “special offers” and other sales gimmicks.

Here’s an example of how monthly payments look over the course of a 30-year loan:

The longer you have a loan, the less you’re paying the bank in interest. So without a really good reason to refinance, I almost never do.

Get the cheapest loan possible right up front, then keep it until it’s paid in full.

Debt Adds Risk

There’s a reason why financial advisors urge people preparing for retirement to pay off as much debt as possible.

Debt creates more risk for you as a borrower. With higher debt liabilities and higher monthly costs, you need more income to cover your expenses. If something happens to that income, you’re in a lot more trouble if you have more debt.

Imagine two landlords with identical homes side by side. One has a mortgage costing $1,000 per month, and the other owns the property free and clear. In a stroke of bad luck, the tenants of both units move out simultaneously. And not only are the landlords not receiving any rental income, they also need to spend a few thousand dollars on new paint, new carpets, and other regular maintenance.

One of these landlords is in dramatically worse shape than the other—to the tune of $1,000 every single month that goes by with the property vacant.

Debt can be useful, when used skillfully as a tool to create wealth. But the more debt you have, the higher your financial risk. Period.

Final Thoughts

There are sometimes good reasons to refinance, whether as a homeowner or landlord. But just as often it merely adds unnecessary extra closing costs, life-of-loan interest, and risk in your portfolio.

Be strategic about using debt to acquire income-producing properties. Leverage helps you build a portfolio at speed. As you grow your portfolio and start moving closer to financial independence, start thinking about paying down debts rather than growing at the fastest pace possible.

At a certain point, it makes more sense to reduce your liabilities and earn more money from fewer properties. Each property takes work to manage, after all!

Most of all, run the numbers before committing to a new mortgage, because you’re working with sums in the thousands of dollars that you would ordinarily treat with grave reverence. It’s only the context of hundreds of thousands of dollars in loans and values that sums like $5,000 look small, so fight your brain’s instinct to treat it as relative and treat it with the full respect it deserves.

Sources

  1. https://www.housingwire.com/articles/50098-cheap-rates-create-record-high-in-refi-eligible-population/

Are you considering refinancing in light of today’s low interest rates? Why or why not?

Discuss in the comment section below.

G. Brian Davis is a landlord, personal finance expert, and financial independence/retire early (FIRE) enthusiast whose mission is to help everyday people create enough rental income to cover their ...
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    Wilson Churchill from Madison Heights, Michigan
    Replied about 1 year ago
    Another reason to refinance would be to add CASH to your bank account. It can reduce risk to have more cash, as long as the urge to invest it is resisted.
    G. Brian Davis from Baltimore, MD
    Replied about 1 year ago
    I hear you Wilson, although I don't want pay money for my cash. I want my cash paying me money!
    Brian Costanzo from Frederick, Maryland
    Replied about 1 year ago
    The way to accelerate the loan pay off is “velocity payments” using HELOCs. Setting it up is low cost or free, then you have opens to expand or start paying off debt FAST. Of course there is more to it.
    G. Brian Davis from Baltimore, MD
    Replied about 1 year ago
    Why not just pump more money toward your mortgage to pay it off faster?
    Santiago Marquez Rental Property Investor from Bronx, NY
    Replied about 1 year ago
    Yea Velocity Payments is an interesting one. I currently am part of an accelerated program w/Quicken Loans. But This is only making 1x extra payment out the yr. So instead of 12 we make 13 🤔 I know it's NOT that crazy but I'd rather be apart of something where i can get that PRINCIPAL DOWN asap. When i can I also send a couple of extra $25, $50 or $100 to PRINCIPAL. But working the HELOC would probably take it down drastically. I'd have to put my thinking cap on for that, lol. Anyone on BP ever utilize their equity/HELOC for this reason? If so, what's your amount? How long did it take for you to get there?
    Alex G. from Eastern Mass & Central Maine
    Replied about 1 year ago
    You should do no closing cost refinance. Period. However, you should not do a cash-out refinance without a compelling reason.
    G. Brian Davis from Baltimore, MD
    Replied about 1 year ago
    I'm with you Alex on not doing a cash-out refi without a very good reason!
    Dale Snider from Denton, TX
    Replied about 1 year ago
    What about this concept: refi after a year or two for 1% or more in APR saving a few hundred a month. Keep paying that savings towards principal. Over 30 years you could save much more than the closing costs of the new loan and cut the 30 to maybe 20.
    Katie Rogers from Santa Barbara, California
    Replied about 1 year ago
    Considering that about half of the final out of pocket cost upon the conclusion of the 30 years is interest, accelerating the payment of principal even beyond the refi savings is likely to save a lot more money than a refi.
    Katie Rogers from Santa Barbara, California
    Replied about 1 year ago
    Those mathematical disadvantages to a refi make almost any refi not worth it.
    G. Brian Davis from Baltimore, MD
    Replied about 1 year ago
    I agree Katie - almost never worth refinancing.
    Eric Carr Real Estate Broker from Los Angeles, CA
    Replied about 1 year ago
    Great article. Think it through and do that math to be certain it makes sense. Decide on your horizon or tolerance for debt and the end goal, and with which and number of properties. Debt can also help a property that is negative or struggling with cash flow - and since the tenants are paying it off, if you have a long enough timeline, it's something to consider. Just be smart about it and not rush into a flashy apr, using equity for bad decisions, or underestimating costs to refinance.
    G. Brian Davis from Baltimore, MD
    Replied about 1 year ago
    Thanks Eric, and you're absolutely right - it comes down the math!
    Dave Rav from Summerville, SC
    Replied about 1 year ago
    Man, are we really at the mid-3's on interest rates?! Thats amazing. I have this duplex sitting at 6.5% (before you gasp, please note I bought it 2008 and haven't refi'd due to the reasons aforementioned - closing costs, appraisals (it wouldn't appraise for the last 5 years), and fees). Right now, I break even on profits, so why would I jump to an automatic loss of say $3-4k from a refi? How long would it take me to re-coup that? (all things G. Brian mentioned in the article). By the way, I welcome comments and maybe a little help with advice here!