In the Time of COVID-19: To Refinance or Not to Refinance; Finance Faculty Give Advice
By Keith Morelli
TAMPA (October 15, 2020) -- As COVID-19 continues to blanket the nation for the seventh consecutive month, laid-off or furloughed workers struggle to make mortgage payments. However, does the pandemic present certain opportunities for those facing adversity in the home-ownership department?
Does it make sense to refinance or take out second mortgages? Real estate and financial planning faculty at USF’s Muma College of Business take an informed look at the cold, hard facts and make some observations on how to proceed in this time of uncertainty.
“Mortgage rates are hovering near historic lows – the 30-year is just above 3 percent,” said Dan Bradley, a professor in the Kate Tiedemann School of Business and Finance. “For most people who have not refinanced within the past year, it is probably worth it.
“One needs to weigh the cost of refinancing (i.e., closing costs) into the interest savings and estimate how long they plan on staying put,” he said. “For instance, with a $250,000 mortgage, a 1 percent decrease in the mortgage rate would equate to about $140 per month. Homeowners have to weigh this interest savings versus with the cost of refinancing.”
Bob Tiller, a finance instructor and Raymond James Financial Director of the Personal Financial Planning Program, agrees.
“Mortgage rates are still quite low, so those who could consider refinancing should learn the formula to determine if it is worth it or not,” Tiller said. “It might also be appropriate to discuss how COVID-19 mortgage forbearances might factor in for those wanting to refinance.
Tiller said that since the country began its isolation seven months ago, homes became more than living quarters. They turned into schools, offices, restaurants and playgrounds.
“So,” he said, “it makes sense that many people are thinking about the treasure within their homes, asking: ‘Is this our forever home?’ ‘Should we redecorate, remodel or expand?’ ‘How might we afford these renovations?’
“All of which could lead to many folks asking, ’Should we refinance?’"
When considering a mortgage refinance, as with any major financial decision, Tiller said, it is always wise to start with a broad look at the family finances.
“Know where you stand with your cash flow,” he said. “Write down what comes in, what goes out and use an online mortgage payment calculator to see just how much lower your monthly expenses could be if you did refinance. Better yet, ask an experienced, financial planning professional to help you.
“Keep in mind that refinancing to a lower mortgage rate could also be a bad move if you don't stay in the house longer than will be necessary to overcome the loan origination fees or points associated with obtaining the new mortgage,” he said. “Ask yourself what the likelihood is that a planned or unexpected moving circumstance would arise – such as relocation for work, family needs, retirement, marriage, divorce or significant health decline.”
Financial planners sometimes recommend mortgage refinancing to their clients if it will allow them to redistribute their monthly cash flow toward more of the families' other important financial priorities, such as insurance, education funding or retirement savings, he said. Yet, they may also caution their clients against the notion to "cash in" on a recent increase in home equity to spend on lower priority wants or wishes ahead of family needs.
“Repeatedly stripping the equity out of rising home values was a refinancing cycle that left many Americans ‘upside-down,’” he said, “with outstanding mortgage balances higher than their home values, during the last housing market downturn a dozen years ago.”
In keeping with the adage: "It is sometimes better to strengthen the back than lighten the load," he said, financial planners prefer helping clients learn to better manage and pay down their short-term and intermediate-term debt (like student loans, car loans or credit cards) rather than simply convert it to long-term debt financing through repetitive mortgage refinances.
“A mortgage refinance to significantly reduce the interest rate differential from high-rate debt accounts may have some merit,” Tiller said. “However, using this financial lever without living within one's income could generate significant long-term consequences.”
In Florida, the current trend in foreclosure rates looks particularly worrisome, said Martina Schmidt, a real estate and finance instructor with the USF Kate Tiedemann School of Business and Finance. Florida is among the five states with the highest foreclosure rate in August. Pre-foreclosure filings during that month increased by 1,258 percent from July, according to RealyTrac and Gov. Ron DeSantis has already ended the foreclosure moratorium in Florida as of Oct. 1.
“This will only add to the woes of many Florida homeowners in the months to come,” Schmidt said.
Due to record low interest rates, refinance activity has been very strong through the second quarter of 2020, she said. Industry observers predict $1.75 trillion worth of mortgages will be refinanced in 2020, a record not seen since 2003. Most of the re-financing activity so far has occurred in the $300,000-$500,000 range.
Before refinancing, Schmidt said, homeowners should be mindful of the following:
- Be very clear about financial goals of refinancing. For example, do you want to reduce the payment amount or do you want to reduce the number of payments left. Your goal will help to select the right mortgage product.
- Determine how much equity you have in the home. The more equity the better loan terms.
- Check on your credit score. The higher the score, the better, as this will result in a lower rate.
- Shop around for rates. Make sure that the lenders quote you a rate without points and upfront fees.
- What is your career situation? For example, if you currently hold a job with a steady paycheck, which you may be leaving soon for a more entrepreneurial endeavor, now is a good time to refinance.
Schmidt urged homeowners to remember that refinancing is not free. Refinancing costs of an average home are about $5,000, or roughly 2-5 percent of the loan amount. She said the break-even time for the refinance loan must be determined.
“If the length of the loan does not change, take the refinancing costs and divide that number by the monthly saving from the lower interest rate,” she said. “That will result in your break-even months. If you do not plan to stay in the current home for that long, it is not worth refinancing. If you refinance into a longer maturity loan, remember that the more payments you make the more interest you will pay.”