We recently finished the process of refinancing the mortgage on our home. Initially, we thought the effort would not be worth it; however, after setting refi goals, getting in touch with lenders, and running the numbers we couldn’t pass on this opportunity. In the end, we were able to lower our rate by 0.625% and realize a decrease in our monthly mortgage payment of 21%.

Refinance Goals

Initially, we debated whether or not a refi would work for us. The reason I say that is because our original 30-year-fixed mortgage was already competitive sitting at 3.125%. My gut was telling me that exploring refinancing would probably be a waste of our time.

Back in June, a member of my team mentioned she was about to close on her refi from a 30 to a 15-year mortgage. She was pretty happy with the process and their lender so I asked for their contact information to get a feel for available options and to let the data influence our decisions.

“If we have data, let’s look at data. If all we have are opinions, let’s go with mine”

Jim Barksdale, former Netscape CEO 32

Unfortunately, after sharing our goals to (1) stay with a 30-year loan term and (2) achieve a break-even of less than 12 months, we received confirmation that refinancing would not be a smart move for us.

Even though interest rates were at historical lows, they were still hanging close to our existing interest rate (without buying points). In order to have access to an interest rate of a mid-to-high 2%, we needed to (1) switch to a 15-year mortgage or (2) buy a lot of points neither of which were acceptable options or us. Based on this conversation we decided to put the thought of refinancing to rest.

One day I was reading stories on our local ChooseFI Facebook group and noticed comments from people who were refinancing their homes to 30-year terms getting ~2.5 to 2.875% interest rates with minimal closing costs. They mentioned the credit unions they worked with so we decided to give them a call.

We received estimates from two (2) local credit unions that quoted 2.75% and 2.875% with closing costs equivalent to 12 to 15-month break-even based on the new monthly payment. That got us excited so we decided to entertain the idea of a refi one more time.

Researching & Picking Our Lender

Aside from the two (2) credit unions we reached one to a lender we found on credit karma and one broker who was recommended by our realtor. The lender we found via credit karma quoted 2.875% with similar closing costs and the broker offered 2.75% but closing costs were more competitive compared to the local credit unions.

We spent time looking at every line item on the unofficial loan estimate from each lender. In general, they were all pretty similar but the local credit unions were charging 0.25% of the loan amount in case we wanted to avoid setting up an escrow account to pay property taxes.

I know a lot of people include property taxes in their mortgage payments. While I don’t think setting up an escrow account is a terrible idea; having your money sitting around doing nothing is. A better option is to open an online savings account or use that money to get bank account bonuses. We’ve been homeowners for 5 years and have the discipline to follow this approach. If you don’t, then an escrow account might be best for you.

When we checked the estimate from our broker we found that this fee was not included. I remember talking to him over the phone and asking him about that fee. He confirmed it would not be included. I reached out to one of the credit unions (the one that was more competitive) and they said they could try to waive it but that it needed supervisor approval along with the loan estimate from our broker.

Ultimately, we decided to initiate the loan process with our broker. Below are some of the reasons we went in this direction.

• Our broker challenged the idea of refinancing: He mentioned that our existing rate was very competitive so he didn’t understand the why of a refi. It was refreshing to hear somebody asking questions instead of just doing things because we asked.
• Setting explicit goals for refinancing: we had a conversation about our goal to refinance to a new 30-year loan term with an interest rate that would yield monthly savings and short-term break-even.
• Clear expectations: we discussed that by re-setting the loan term we would end up paying more in interest; however, we discussed the concept of opportunity cost and the present value of money. This gave more context to our broker. In the end, it seemed like we had to convince him to work with us.
• Achieve a competitive interest rate: we were surprised to see that our broker was always more competitive than the local credit unions.
• Competitive closing costs: no need to open a bank account with a given credit union and no costs associated with waiving an escrow account.
• Communication: this should be at the top of the list. We were extremely happy with the communication and support we received from day 1. Our broker answered all our questions and was accessible at any time of the day. Towards the end, we were texting each other to make sure all the paperwork was ready and also to trigger locking our rate.
• Time to close: due to the high demand of refis we were told the process could take around two (2) months or more. Our broker helped us close in 38 days.

Resetting a 30-year Loan Term

We were in year 5 of a 30-year loan term. We thought about refinancing and adjunting the term to 15/20/25-year term but we ultimately favored the flexibility of the 30-year loan term. Yes, the interest rate is a little bit higher but not too far off. In addition, the monthly payment of a 15 or 20-year mortgage was so high that it was just not possible to handle based on our budget.

Present value of money and opportunity cost were also big drivers. Yes, we may end up paying more in interest but that is based under the assumption that we’re staying in our home for 30-years (unlikely) and that no additional payments will be made.

The beauty of a 30-year mortgage is that it provides significant flexibility.

If we want to pay it sooner, we can; but we’d rather invest our monthly savings in the market or build capital to buy rental properties. Either of these cases has a better value proposition than paying off a loan at 2.5%.

The graph below shows a quick analysis comparing the total cost of our loan (interest) and the potential returns investing the monthly savings. Once again, the assumption here is that we stay at our home for 30 years and we make no additional payments. In addition, we assumed an annualized return from the market at 7%.

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Look, I get it. Some people like the peace of mind that comes with not having a mortgage payment. After all, housing is the number one expense of most households.

We look forward to being mortgage-free; but not at the expense of having money locked in a non-producing asset.

Running the Numbers

If you want to evaluate scenarios for refinancing the math is easy and straightforward. All you need is Excel’s loan amortization template or this Google sheet.

You can use trial and error or Excel’s goal seek to calculate the interest rate that when combined with monthly savings and closing cost would yield a certain break-even. Here’s the formula.

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Where:

• Total Closing Cost from official loan estimate ($)
• Delta Mortgage Payments is the difference between your current and new mortgage payment in ($)

You can re-arrange this formula to calculate the new monthly payment to meet a given break-even assuming a range in closing cost. In our case, we evaluated changes in our closing costs and associated monthly payments to estimate our break-even. We had a rough idea of where we needed to be in terms of closing costs and interest rates. Our broker monitored interest rates daily and when our number showed up he provided us with an updated loan estimate and we proceeded to lock a 2.5% interest rate.

No Need for An Escrow Account

We don’t really see the point of setting up an escrow account to pay for property taxes. This type of account pays 0% interest so we’d rather do anything but leave it sitting doing nothing.

Look, we are big believers in paying yourself first and automating your finances. Instead of including property taxes on your mortgage why not automate your savings for this specific bucket using an online savings account that at least gets you 1.0% APY?

Often people that lack discipline talk themselves into going for the escrow account approach and I respect that. As long as you’re aware of your decisions and consequences everything should be good. Yes, you’re probably leaving a little bit of money on the table but it is not significant to make you rich or poor.

Our Mortgage Is Likely To Be Sold

One of the things we discussed with our lenders was whether or not our mortgage will be held or sold. Two (2) credit unions mentioned they would keep them for the duration of the loan, the lender I found on credit karma, and our broker said they would more than likely be sold.

We are no strangers of having our mortgage sold. As a matter of fact, the mortgage on our first home in Texas was sold 2 or 3 times. We were always notified via email so as long as the new company received online payments we didn’t really care.

When we moved to Colorado, we financed our home with Wells Fargo. This was our first time having a mortgage with an institution for the entire duration of the loan. It was nice to set up automatic payments and forgetting about it.

Our goals for refinancing was to (1) get a competitive rate and (2) realize a breakeven of less than 12 months. Keeping the loan under one roof was never included in our decision criteria. These days, most lenders accept online payments so as long as that is available we should be good.

A Note On Credit Score

Before I wrap things up it is worth mentioning that your credit score is key for qualifying for competitive rates. The only reason we were considered for rates under 3% was based on having a credit score of 750+. My intent is to brag about this but to raise your awareness and make sure that you manage expectations. The lower your credit score the higher the interest rates lenders will offer.

Additional Fees Coming in December of 2020

Fannie Mae and Freddie Mac had announced earlier in August that they would begin charging lenders a 0.5% “adverse market” fee on all refinances beginning on Sept. 1. Our broker provided us with a revised loan estimate and we decided to stop the process.

Thankfully, they decided to wait until December to implement the fee which allowed us to go back to our original loan estimate and proceed with closing on our refi.

Final Thoughts

• It’s ok to trust your gut but when it comes to money you have to do the math. I was happy to see that we were wrong and that based on our goals, refinancing was indeed an option for us.
• Credit unions and local banks offer better rates than bigger banks; however, do not underestimate the power of using a broker.
• Be clear about your goals for a refi. Do you want to switch to a different loan term, lower your mortgage payment, or do a cash-out refi? Furthermore, what is your tolerance for time to breakeven?
• Make sure you get a loan estimate from different lenders and pay attention to every line item.
• Pick your top-two lenders, start the loan process, and fine-tune your numbers to make a final decision.
• If you want to achieve a breakeven of less than 12 months you need to pay close attention to your closing cost. Furthermore, If you wait until December you will be hit with the extra fee that Freddie and Fanny will start imposing on all lenders.