Analysis: How low can mortgage rates go?
NEW YORK (Reuters) - Mark Sass and his wife Jan decided to refinance the mortgage on their Cincinnati, Ohio, home on Friday, just days before the Federal Reserve pledged to keep rates near historic lows through the first half of 2013.
"I knew the Fed statement was coming out and rates had dropped to historically low levels, and it just seemed like an opportune time. I hadn't even thought about it until then," says Sass, who owns his own marketing research company.
Their original mortgage had a 20-year amortization period - at a 4.875 percent rate - with 12 years remaining. They are rolling it over into a 10-year mortgage with a 3.5 percent rate. "I was able to knock a couple of years off the term with a very modest increase in the monthly payment," Sass says. "It seemed like a no-brainer to me."
Sass and his wife are both 55, so retirement is on the horizon. "The opportunity to look 10 years out and know that - unless things change - we won't have a mortgage when we retire looked like a smart decision," Sass says, adding the overall savings on interest by reducing his term will be in the neighborhood of $20,000.
Sass is one of many jumping on the refinance bandwagon in the wake of the current financial crisis. Mortgage applications shot up 21.7 percent for the week ending August5, according to the Mortgage Bankers Association Market Composite Index. The spike was largely driven by a 30.4 percent jump in the group's refinancing index.
"In a few years, these rates will be a memory that people talk about at cocktail parties. Just like when our parents talked about how low interest rates were when they bought their homes," says Dan Nigro, principal at Warfield Consultants in Montclair, New Jersey. "These are the kind of levels that people should lock in for the long term and it certainly is what the government has in mind."
But the question remains: With the average rate on a 30-year fixed mortgage hovering just below 4.5 percent - the lowest levels for 2011 according to LendingTree.com - should consumers jump to refinance or buy a new home? Or should they wait for a new bottom?
Now is the time to act, says Alex Stenback, who writes at the blog "Behind the Mortgage" and is a mortgage banker with Residential Mortgage Group, a division of Alerus Financial. "Don't get lulled into a sense of complacency over what the Fed says about interest rates. They can move up, and this window can shut much faster than people imagine," he cautions.
Greg McBride, senior financial analyst at Bankrate.com, agrees. Since Standard & Poor's downgrade of the U.S. credit rating from AAA to AA on August 5, Treasury yields have fallen. "But mortgage rates aren't going down at the same pace," McBride says.
Mortgage rates tend to mirror long-term U.S. Treasury rates, which have declined in recent weeks. The benchmark 10-year Treasury note hovered around 2.12 percent late Wednesday and set a record low auction yield of 2.14 percent the same day.
If you're convinced now is a good time to refinance your existing mortgage, or buy a new home, here are some ways that traditional advice is playing out in today's market:
1. Shop around for your lender
Cast a wide net when looking for a lender. Do your research and look for alternatives. Check with your local credit union to see if you're eligible for a membership rather than getting lured by major institutions advertising low rates. The Internet offers an array of sites devised to help you find the best lender and rate for you. Bankrate.com's refinance section is a great place to start.
"You want to apply, ideally, with two to three different lenders on the same day. Rates change all the time and you want to facilitate an apples-to-apples comparison. If you apply on the same day, when you look at the good-faith estimates you can make a good comparison of not just the rate but also the fees that will be charged," McBride says.
Sometimes you need to play hardball. Ken McDonnell, director of the American Savings Education Council with the Employee Benefit Research Institute, refinanced his mortgage last week. After researching online, he contacted a number of lenders in his area and approached his mortgage holder with the best offer he found. "I contacted Bank of America, who was my mortgage banker for the past 13 years, and told them the rate I'm getting from Aurora Financial - 3.6 percent and $3,000 in closing costs - and asked could they match it or do better and they didn't," he says.
By switching lenders, McDonnell reduced his rate from 4.5 percent to 3.6 percent, which saves him $291 on his monthly mortgage payment.
2. Do your research on costs
Will the costs associated with refinancing justify the reduced monthly payment? The typical rule-of-thumb is a homeowner should refinance if they can save a full percentage point on their rate.
Bob Davis, executive vice president of the American Banker's Association, cautions against applying the broad-blanket, one-percent rule. Consumers need to consider individual costs to modify versus change lenders, annual savings on the reduced rate, how long you'll likely remain in the home, the change in an interest rate tax deduction, title insurance, escrow waiver fees and other charges.
"The cost of those variables may be different … there is a break-even point there. It may take you three years to get back your out-of-pocket expenses. If you're planning on staying in your home seven years, than that's a good thing to do but if you're only staying in the home two years, it will cost you more to refinance," he says.
For McDonnell, the cost to change lenders was minimal. Two-thousand dollars of the $3,000 in costs were rolled into his mortgage, and after closing his escrow account with BofA, he received a $1,700 refund. "It's going to be a very small amount that's coming out of my pocket," he says.
In the unwritten rules of refinancing, your monthly mortgage payment savings should equal your closing costs within 12 to 18 months. In McDonnell's case, he'll break even in 11 months.
3. Request a copy of your credit report
While there may be an incredible incentive to refinance due to low rates, be sure your credit history is in order before approaching a lender.
To lock in the lowest rates, consumers will need a FICO score of at least 760 to even be a contender for refinancing, Nigro says. "These are very tight credit underwriting regulations and when you combine that with the fact that 25 percent of Americans have a loan-to-value that exceeds 125 percent of the value of their home, it means that a large amount of people are eligible to refinance but less than 20 percent of all of those who have the rate incentive can refinance because of their credit score and/or the equity they have in their home."
Everyone is entitled to a free annual credit report from each of the three nationwide credit agencies: Experian, Equifax and TransUnion. Log on to www.annualcreditreport.com for your quarterly update.
You never know, you may be pleasantly surprised by your credit score, says Sass. "Both of our kids are out of college, we have no credit card debt so I knew the (credit) score was going to be high. It makes life a lot easier and there are a lot less questions to answer."
(Editing by Beth Gladstone)
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