refinance

Is window closing on a great refinance?

Charles Delaney, Ph.D.As mortgage rates drop to historic lows, borrowers everywhere rejoice. Rates have fallen below 4 percent, allowing millions of homeowners to refinance and lower their monthly payment by hundreds of dollars.

It is a great time to borrow -- but it is unlikely to stay that way forever, says Charles Delaney, associate professor of finance and director of the real estate program at the Hankamer School of Business at Baylor University in Waco, Texas.

If you are still sitting on the fence wondering if you should wait for mortgage rates to sink even lower, Delaney has two words for you: "Get wise." He explains his thoughts in the following interview.

With mortgage rates below 4 percent, is now the time to refinance?

I would say it is a great time to refinance. My rule of thumb has always been if the savings from refinancing outweigh the costs for the time period you project to continue living in the home, then yes, it is certainly something someone should consider. Let us say that you can refinance for $1,000. Those would be your costs of refinancing. And you can save $100 a month on your monthly payment of principal and interest.

Well, you have $1,200 of savings relative to a $1,000 cost. That is a 20 percent return. Most people are not getting anywhere near that with their savings. So that is why I say virtually any time is a good time to refinance. But you have to look at the savings relative to the cost, and then consider, "How long am I going to be in this property?"

Besides cost, what should homeowners keep in mind before deciding to refinance?

Is their home worth more than the amount they need to refinance? Or said another way, are they underwater? That is a situation where people owe more on their existing mortgage than … what their home is worth. If they are in that situation, it is going to (be) virtually impossible to refinance.

Lenders typically want a loan-to-value ratio of 80 percent or less. They want a cushion between what the property is worth and what you owe them in case you default, and they have to foreclose and sell the property to satisfy the debt. They want a bit of a cushion between market value and what you owe. It reduces the likelihood that if they do have to foreclose and take your home that when they sell it, they will not recover an amount sufficient to pay what is owed.

So if you are underwater, you owe more than what your current home is worth, you are probably not going to be able to refinance.

Now a lot of people in the past that could refinance do not. And I think there are a number of reasons for that as well. Inertia or procrastination. Some people are very fearful. They are intimidated by the banks and the whole process of mortgage lending. Some people are ignorant of the fact that they can refinance. Others, they just do not want to deal with the hassle or bother of going through the paperwork and applying and that type of thing, even when they realize they could save money.

So none of those are really what we call "rational," but yet those are some of the reasons why people who could refinance do not.

What advice can you give to people who have not yet considered refinancing their home?

If they are like many people living from paycheck to paycheck, if they can refinance and save $100 or $200 a month on their mortgage payments, that is additional disposable income they have to spend on groceries, gasoline, a night out with (their) kids. Or maybe they can use that money to invest or save. So there are a lot of financial reasons that I think people should consider as a motive to refinance.

Do you think mortgage rates will go any lower?

They were pretty close to the historical low. They could tick down a little bit. I do not see them changing much in the next few months, but I think the probability is much greater that they will increase rather than go down substantially a year or two down the road. I just cannot see rates going a whole lot lower than what they are already.

And the thing about refinancing many people do not understand, too, is if you look at what was going on in the early '80s when mortgage interest rates were in the high teens, 18 (percent) and 19 percent of people would refinance multiple times. As market rates would fall, they would refinance. They would fall some more, they would refinance again.

And so I think there are some people out there that do not understand that if they refinanced today at 4 (percent) and then six months from now let us say rates fell to 3 (percent), they could refinance again. Now, you have got to consider the transaction costs, of course, and how long you intend to be in the property, but the problem with waiting for mortgage rates to fall is like trying to catch a falling knife. You are probably going to get cut.

And if I were advising someone, I would say, "Get wise." We are pretty close to the lowest rate we have seen in decades. Maybe it could go down another 25 basis points or 50 basis points. But look at the risk you are taking in not refinancing. What if they go to 5 (percent) or 6 (percent) or 7 percent?

And you know eventually, we will see mortgage interest rates rise again.

The Federal Reserve, through its QE -- quantitative easing, purchasing securities in the open market -- has kept interest rates and mortgage rates low. But that is not going to go on forever.

We would like to thank Charles Delaney, associate professor of finance and director of the real estate program at the Hankamer School of Business at Baylor University in Waco, Texas, for his insights. Katie Doyle, managing editor for Bankrate.com, contributed the questions for this interview.

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