As the mortgage refinancing boom rages, millions of homeowners have yet to swap out their old mortgages for new loans at record-low rates. A significant number of Americans are hanging onto 30-year mortgages with rates of 5 percent or higher.
Why are so many homeowners still locked into above-market rates? “The same reason people don’t go to the dentist regularly even though they should – it’s not fun,” says Greg McBride, CFA, Bankrate chief financial analyst.
Enjoyment aside, mortgage data firm Black Knight says a record 19.3 million homeowners could save money by refinancing. As of July, 7.6 million Americans had 30-year fixed-rate mortgages at rates of 5 percent or higher, Black Knight says. An additional 17.6 million homeowners had 30-year rates ranging from 4 percent to 4.875 percent.
The average rate in Bankrate’s weekly survey for the 30-year fixed mortgage is 3.11 percent. So a substantial number of homeowners could save on their monthly payments but haven’t. The sheer complexity of the mortgage market could explain some of the reluctance.
Qualifying for and closing a mortgage is a complicated transaction with many moving parts. Even savvy consumers can struggle to make sense of mortgage offers that include a jumble of jargon and a wall of numbers.
Paperwork, income interruptions pose hurdles
Applying to refinance can be a tedious process. Borrowers need to compile tax returns, bank statements, paychecks and other documents. Scanning and uploading those documents poses something of a technical hurdle for some. And lenders are looking at the paperwork even more carefully as the pandemic has thrown millions out of work.
However, while documentation requirements became more strenuous after the Great Recession, they haven’t changed much in recent years, says Gordon Miller of Miller Lending Group in Cary, North Carolina. “The impression is that it’s harder and more paperwork is required, but if your income isn’t impacted, it’s the same as it was a year ago,” Miller says.
That’s a significant if, of course. Unemployment spiked into the double digits this spring and remained above 8 percent in August. Many homeowners who’ve had interruptions in their income don’t qualify for refinancing.
“Many quality borrowers have taken pay cuts and many others lost their jobs,” Miller says. “High-quality borrowers can become non-quality pretty quick.”
Closing costs can prove daunting
For borrowers who qualify and who are willing to spend the time to apply for a refinance, closing costs are another obstacle. These costs can range from 2 percent to 5 percent of the amount of the loan — a sum that can overwhelm the monthly savings.
“Refinancing isn’t free, and sometimes it’s tough for people to look past the out-of-pocket costs incurred now for savings that will take years to accumulate,” McBride says.
Say you have a $250,000 loan at 3.75 percent. Your monthly principal and interest is $1,157. If you can lower the rate to 3 percent, your payment would fall to $1,054, a savings of $103 a month.
But even if your closing costs are $5,000 — at the low end of the 2 percent to 5 percent range — you won’t break even on the costs for four years. If you plan to stay in the home for five years and not refinance again in that time, then the refi makes sense.
But if you’re planning to sell next year, or to refi again in two years, you’re actually increasing your costs, not saving money.
If, on the other hand, you have a loan at 5 percent, your calculations become simpler. A $250,000 loan at that rate carries a payment of $1,342. Refinancing to a 3 percent loan would cut your monthly payment by $288 — making the $5,000 in closing costs easier to swallow. Your breakeven point in that case would be less than a year and a half.
Lenders have been flooded with refinance applications, so they might not be eager to negotiate on closing costs, Miller says. For a borrower who locked in a good rate in recent years, the prospect of paying $10,000 in closing costs is a deal-breaker. “Closing costs are blocking too many borrowers who are already near 4 percent,” Miller says.
Waiting for lower rates might not be the right move
Meanwhile, some homeowners haven’t refinanced because they’re holding out for rates to fall even further, says Gino Moro of Southland Mortgage in Hollywood, Florida. He advises them against trying to time rates.
“Now is the time to pounce,” Moro says. “There’s a lot of room for rates to go up, and not much room for them to go down.”
The economy is another wild card. Many homeowners have had interruptions to their incomes, which makes it harder for them to qualify for new mortgages.
Even so, Black Knight says there are 19.3 million homeowners who are in good financial shape and could qualify. The average monthly savings for those refinance candidates is $299 – a total of $5.8 billion a month if all refinance candidates were to take advantage of the opportunity, Black Knight said.
The eye-popping numbers are made possible by a historic decline in mortgage rates. Black Knight’s figures are based on Freddie Mac’s average 30-year rate, which last week fell to a record low of 2.86 percent. (Freddie Mac’s number is lower because Bankrate’s figure includes points and origination fees averaging 0.33 percent, while Freddie’s number excludes those costs. Freddie Mac said its average is accompanied by an average of 0.8 of a point.)
Rates are at record lows, but mortgages aren’t easy to get. Worried about the effects of the recession and the risks of elevated unemployment, banks have boosted requirements for credit scores and home equity, and they’re scrutinizing borrowers’ employment situations. Overall, lenders have tightened the availability of credit, the Mortgage Bankers Association said last week. The supply of mortgages fell to its lowest level since March 2014.
What you can do
To score the best deal on a mortgage:
- Shop around. Closing costs and rates vary by lender, so get three bids.
- Make sure your credit score is up to par. This is the single most important variable in determining your rate, so make sure to pay your bills on time and to use only a fraction of your available credit limits.
- Understand the breakeven point. That’s the moment at which the savings in monthly payments offset the amount of the closing costs. This refinance calculator can help you decide.
- Don’t chase the lowest rate. Yes, a low rate and paltry payment are good, but make sure those benefits aren’t overwhelmed by closing costs.
- Consider rolling the refi costs into the loan. If you don’t want to come up with the cash, lenders can either absorb the costs by giving you a slightly higher interest rate or increase the principal of your loan to cover these costs. Be sure to work out the costs of this scenario.