The Art of the ReFi, by Jason Hillard, Home Loan Ninjas Blog

I was asked by Portland Realtor Fred Stewart recently if I wanted to write an article on refinancing for his blog, Oregon Real Estate Round Table. This became a challenge that I was not expecting.

I set out to see what the competition is “blogging” about the topic of refinancing. What I found is more of the same: advertisements disguising themselves as blog posts. I guess I should keep in mind that my blood pressure usually skyrockets when I read other mortgage blogs.

So let me walk you through how/why to refinance in the current mortgage environment. The first step is admission, and is perhaps the hardest thing to come to grips with:

You do not own your home.

If you have a home loan, then the bank owns your home. You own the equity. You may not have equity. You may just own a mortgage. This idea may sound counter-intuitive, but once you accept it and move on, your view on refinancing may change. You should now be thinking, “how can I leverage the portion of my home’s worth that I actually own?”

If you’re still having trouble, consider this. You are thinking about your “home”. I am talking about your “house”, and the debt instrument against it, which is owned by a bank. Separate your emotions from this exercise.

Now, I am a firm believer in the concept of Mortgage Planning, which has at its core a very simple concept:

Untapped equity does you no good.

Let me give you an example. If you own $60,000 in home equity, well then let’s start by saying that you are in much better shape than most. However, if you choose to leave that equity in the “untapped ether”, it is nothing more than the theoretical result of a process that you may or may not engage in. In other words, if you are not selling your home in the next 3 years, who cares how much equity you have? Who knows what your home will be worth in 3 years?

Now let’s take it one step further: what if you lose your job? What if you could really use that $60,000 while you look for a new job? Well, good luck qualifying for a refinance without any income. It won’t happen. So, having $60,000 in untapped equity, which is the percentage of the house you ACTUALLY own, is completely useless. Had you taken that equity out when it was readily available, you would have a $60,000 slush fund for a rainy day.

This method of managing equity requires restraint and discipline, but you can see that it illustrates the outdated concept of homeownership. We are all for people “owning” homes, but you have to understand that while you may be a home “owner”, the bank actually owns the lion’s share of the four walls that comprise your house.

So, when I hear some mortgage agent saying “rates are at historic lows” and “now is a great opportunity”, my stomach does a backflip. We agree, rates are low. But that is an awfully generic statement. And yes, now is a great opportunity, but for who? The fact is that when it comes to refinancing, the circumstances which need to be considered are highly individualized. What if you can’t get the “lowest rate” because of credit score?

Well, maybe you shouldn’t be so hung up on the rate.

Well, now what in the world would I say that for? Let’s break it down. Say you have a rate of 5.5% on your current mortgage and $40,000 in equity available (“equity available” in this case refers to the portion of your equity which you could actually pull out by refinancing, not the total amount of equity). You also happen to have about $800 a month in credit card payments.

You call up a mortgage professional to inquire about a refinance. Your credit score and LTV (loan-to-value) conspire against you though. The rate you would qualify for is less than .375 lower than your current rate. You ask yourself, “why would I pay $6000 in closing costs for what is essentially the same rate I have now?”

The answer is that by doing so, you have leveraged your available equity to save something like $600 a month on your total monthly “out-go”. This is the equivalent of getting a $600/mo raise in your salary. Also, you have transferred all of the interest from your credit cards to your mortgage, which is tax deductible. This saves you more money. The lesson: don’t get so hung up on the rate. Focus on the outcome.

Time for disclosure: I have avoided using “exact numbers” and precise monthly payments because that requires all kinds of math and figures, which people hate reading and would only serve to muddy the point. You can get exact numbers for your situation by contacting us, or any other mortgage professional.

Let’s review one more situation; one which is much more common for the current market. You have a pretty good rate from a couple years ago, but don’t want to miss out on this “historic opportunity” because it’s all you have heard on the radio for the last 2 years. Of course, since your last refinance was a couple of years ago, you probably don’t have a lot of available equity. So you aren’t looking for any cash out, just a simple rate & term refinance.

Let’s say that your loan amount is such that lowering your rate about .75% on a new refinance only saves you about $120 a month. The old school mentality says “why pay $6275 in closing costs to only save $120 a month?”

After all, that would mean that it would take 52.29 months to pay off your refinancing costs. ($6275/$120 = 52.29)

You’re probably thinking you are losing $6275 in future earnings, which seems like a lot to trade for $120 a month now. However, what if you don’t sell your home? What if the value drops further, and that $6275 isn’t there in the future? What if your salary gets cut at your job? The $6275 is theoretical. The $120 a month savings is tangible. You need to frame the question this way:

Which is more valuable to me? The tangible savings now, or the possibility of return in the future?

We are not recommending you tap yourself out just to save a few bucks every month. That’s the point. The answer to this question should be as unique as the person asking it.

However, you do need to start thinking about your mortgage in this way. It’s a brave new world, and it is likely here to stay.