Your First, Best Move for 2010: Refinance Your Mortgage

Motley Fool guest contributor Brad Hessel manages an investment advising service in North Carolina. He has previously worked in investment banking, and has founded or co-founded a computer game design company, a CASE tool software company, and a knowledge management consulting practice. 

You should refinance. Now!

Many observers are bemused by U.S. policy. Faced with a financial crisis caused by the bursting of an out-of-control residential real estate bubble -- engendered and nurtured by the government's generous lending standards and engineering of loose money and low interest rates -- the response has been to fight fire with fire: still lower interest rates, still looser money, and tax incentives to encourage the citizenry to borrow still more money for houses, cars, etc.

On a macroeconomic level, this response may be hard to fathom, but one thing is perfectly clear: The U.S. government -- the largest debtor in the history of humankind -- is engineering conditions that are extremely favorable to debtors. Interest rates on debt are low, and the value of the dollar is shrinking fast, which means any dollar-denominated debt burden is decreasing daily. Thus, if you own a home, these are perfect-storm conditions for refinancing -- great for borrowers.

But for lenders such as Citigroup (NYSE: C  ) , Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , and HSBC (NYSE: HBC  ) -- plus, indirectly, Fannie Mae (NYSE: FNM  ) and Freddie Mac (NYSE: FRE  ) ... not so much.

First of all, as is common knowledge, rates are at historic lows, dipping below 5% on a fixed 30-year mortgage. If you have a mortgage in the 6%-to-6.5% range or higher --which is likely unless you've already refinanced in 2009 -- this is a no-brainer. Even with a point to point-and-a-half of closing costs, you'll probably end up paying out fewer dollars over the life of the new loan than you have left to pay on your current loan. You will certainly pay less per month. Check out the Fool's section on refinancing and analyze your situation using a mortgage calculator such as this one.

But wait, there's more! If the dollar continues to depreciate (it's depreciated at a compound annual rate of 4% since 2002) due to our increasing national debt, any resulting inflation is to your advantage. This is because even if inflation caused by the dollar's decline drives up the nominal cost of food and energy (and hopefully your salary), your new mortgage payment is fixed, in nominal dollar terms, for the next 30 years. (With rates having nowhere to go but up from here, eschew adjustable-rate mortgages.)

Indeed, if you are confident you can earn, say, a nominal 8% return on any funds you manage (a big "if" but consistent with long-term historical average market returns) AND you have a high enough risk tolerance, then you could consider borrowing more money than you need to pay off your old mortgage and investing the balance ... presuming your credit rating and real-estate valuation are strong enough to enable you to do so.

The same principle applies if you have any personal debt at a higher rate of interest, most especially if that higher rate of interest is not fixed, as with credit card debt. As general interest rates rise, the rates you pay on such debt will most assuredly rise along with them. Therefore, if you have an opportunity to convert that variable-rate debt into 5% fixed-rate debt -- by refinancing with a larger loan than you need to retire your existing mortgage and using the cash to pay down the personal loans -- you should take advantage of today's perfect-storm refinancing conditions.

Finally, if you're 62 or older and considering a reverse mortgage, you should look closely at the fixed-rate version of the increasingly popular loan. It's true that fixed reverse mortgages typically require you to accept a lump-sum up-front payment and therefore aren't as flexible as variable-rate lines of credit. But in an environment with rising interest rates, the amount of interest charged against your loan balance as you receive money from a variable-rate reverse mortgage will rise relentlessly over time. So on balance, a fixed-rate reverse mortgage may be the better choice.

Our recent brush with systemic risk has led us to an unusual investing climate, with increased volatility and risk both for organizations and individuals. Nevertheless, in such extreme circumstances, a careful analysis of macroeconomic and political trends can reveal opportunities, as well. In January, PIMCO guru Mohamed El-Erian famously advised investors to "position their portfolios predominantly under the umbrella of government support rather than outside it." Now the government has extended support to borrowers -- especially itself -- and the macros are telling us it is time to bring your debt under the umbrella, too.

What are your thoughts on refinancing and the direction of interest rates? Let us know in the comments area below.

Guest contributor Brad Hessel has no position in any of the equities mentioned; however, Brad's clients may have such positions. The Fool's disclosure policy includes certain trading restrictions that apply to Brad. However, his clients are not subject to our disclosure policy, and thus are free to trade any such equities.


Read/Post Comments (9) | Recommend This Article (25)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 05, 2010, at 1:39 PM, bstan0906 wrote:

    Great suggestions however with half of the US mortgage holders underwater, that 80% LTV requirement for first trust makes it a tough pill to swallow unless one puts down another substantial sum of cash.

  • Report this Comment On January 05, 2010, at 3:03 PM, divedivapro wrote:

    My credit is perfect and I have made every payment timely but I cannot refinance a second mortgage - which is due to reset in 2011, because I live in Florida, and I am way underwater. No one will touch it. It irks the hell out of me that as a responsible homeowner I am stuck with the unfavorable interest rate.

  • Report this Comment On January 05, 2010, at 3:47 PM, Fool wrote:

    The author seems to be more naive than a regular homeowner like me who obviously knows the interest rates are at all time low and tried refinancing with Wells Fargo and BOA, who wont even talk refinancing because of the drop in home values. They are doing this to homeowners who have paid their mortgages deligently. Before posting such articles I recommend a complete research.

  • Report this Comment On January 05, 2010, at 4:46 PM, johnny64068 wrote:

    If you are underwater on your mortgage, it truly is a terrible thing. There is no doubt about that. However, if your loan is owned by one of the government backed agencies (Fannie Mae..etc...) then there is actually help up to 120%. Many people are only upside down because of the mortgage they chose and not always just because the markets are down. I was able to refinance my loan with no issues and will never have to refinance again. We all hope that the industry and the market turns for the better and if it does while rates are still down, more people will have their chance. I have personally provided financing of over 80MM to my clients this year alone. I work for one of the big beat up "too big to fail" banks. I can tell you that we are lending a lot of money through loans originated for FHA, Fannie, Freddie..etc. The days of your credit score is 750? Here is your loan... are over just like 100% financing (except through some government help programs) is a thing of the past, but we are still helping many people lower their rates and payments.

  • Report this Comment On January 05, 2010, at 5:29 PM, bhessel wrote:

    divedivapro & fool,

    Thanks for your comments.

    The macros favor fixed-rate debtors big time going forward. It logically follows that if you can refinance either to extract more value and increase your debt—which you will be able to pay in future with discounted dollars—or just to lower your interest rate, you should do so.

    But even if you can't swing a refinancing here, so long as your mortgage is at a fixed rate, it will likely look good in coming years as eventually the Fed is forced to hike interest rates to attract continued financing of governmental debt. And even with an ARM, if the value of the dollars you are paying your debt off with declines, you will gain some ground that way.

    I am only too familiar with the vagaries of refinancing; my wife and I are on our second attempt to refinance our 6.125% mortgage after the first one ran out of steam when—following a series of previous misadventures—the lender rejected the appraisal because there were no comparable sales they considered pertinent. :-(

    Anyway, I am sorry if folks who want to but cannot “Refinance Now!” are annoyed by advice that seems at once obvious and bootless, but even if you are in that situation, these macro trends we are highlighting—higher interest rates and weaker dollars—should help you sooner or later.

    Brad Hessel

  • Report this Comment On January 05, 2010, at 5:53 PM, Shawnerz wrote:

    Refinance now? HA! No way!

    As I vet, I refinanced my loan through the VA in to an ARM back in 2005. I didn't know it then, but my loan is tied to the FED rate, not the LIBOR. My interest rate is indexed 2.5% above the Fed rate.

    My ARM reset last May and my interest rate went *down* from 4.5% to 3.2%. Of course, my payments went down also. :-) If the rate stays as it is now, my interest rate will be ~2.7% this May.

    I'm holding on to this as long as I can!

  • Report this Comment On January 05, 2010, at 8:31 PM, NotJesseL wrote:

    Problem with refi is that if you are anywhere under 20% equity (not even underwater), you need to put cash in to do it. This cash may be necessary if you lose your job. So, if you have the 6 - 12 months of savings and the cash to do the refi, or if the refi is essentially costing you no cash, its a no brainer. If you have to tap into savings (not even talking about retirement savings), its not so clear. You are then also betting that you will keep your source of income, or the housing market will become much more liquid.

    Our family could have saved $200 /month, but the appraisal came in much lower than Zillow and to make it work for the banker, we would have needed to dump about 35K into the loan. The flip side of this is that now we have a lot of ammunition to once again, lower our property taxes.

  • Report this Comment On January 05, 2010, at 8:39 PM, xetn wrote:

    I don't have a mortgage or any other debt. Debt is a "fools game".

  • Report this Comment On April 25, 2013, at 4:13 PM, PunkRocker45 wrote:

    I don't know how it was back in 2010 but i just applied for 2.71% 15 year fixed mortgage at http://www.mortgagerefinance.com/

    I've never seen rates so low, you ppl are crazy not to refi

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