Yesterday the 10 year U.S. Treasury Note traded at a record low 1.70%. This is a key interest rate that helps drive the pricing of mortgages.
Even if you are at a seemingly low 4-5% interest rate, it may make sense for you to take advantage of today’s extraordinarily low rates to refinance. This is particularly true if you believe, like many people including myself, that inflation and interest rates are likely to rise over time. People think trends are going to continue as they are for a long time. They take whatever is happening currently and project it out into the future. People have become so accustomed to low interest rates; they can’t really picture them at higher levels. But, not too long ago, money market interest rates were 5% or more. When I started my first job in 1990, the Prime rate was 10%. My colleagues and I in the banking industry thought that was too high. We agreed that a “normal” level for Prime was somewhere around 8%. We never would have imagined Prime falling to 3.25% and staying there for years.
One key question is how long will you be in the property? This determines the amount of interest rate protection that you will need. As of this writing, the published 15-year mortgage rate from a major national lender is 2.875% with 1 point. The 30-year mortgage rate is currently 3.625% with 1 point.
How do you calculate the breakeven point? Determine your closing costs excluding property taxes and insurance, which you would have to pay anyway. Your lender can give you these figures. Calculate a new monthly principal and interest payment based on the remaining maturity of your old loan, and compare it with your current principal and interest payment. This way you are comparing apples to apples in isolating the interest rate savings . Then divide the total closing costs by your annual principal and interest savings. The result is the number of years it will take for you to break even. It may not be as long as you think. If your breakeven period is relatively short, say 2-3 years, and you intend to stay in the property for a while, then there’s really no reason not to refinance. It’s just a matter of going through some paperwork, most of which is done by the lender and your attorney.
If you have had a 30-year mortgage for a while you may want to consider moving to a 15-year. For exampl e, say you have 20 years remaining on a 30 year mortgage at 4.9%. Your payment will go up because of moving from 20 years to 15 years, but the lower interest rate will offset much of this increase.
If we can be of assistance in helping analyze your particular situation, please give your advisor a call.
Bill Hansen, CFA
May 18, 2012