“Nothing is so permanent as a temporary government program.” – Milton Freeman
Refinancing a mortgage is about as fun as doing your taxes or getting a flu shot. But even though the process is long and laborious, significant savings can be gained for those willing to take the plunge. We often are asked if it is a good time to refinance and our typical answer is the very unsatisfying “it depends.” Although that is still the case as things such as your current interest rate, your time/availability, and your living situation all come into play, there is a new development that tilts the decision in favor of taking the plunge to refinance today.
Back in March of this year, the FHA announced a foreclosure and eviction moratorium in response to the COVID-19 national emergency. In short, if you lived in a house with a mortgage that was FHA-insured, which most “conforming mortgages” are, then you could not be evicted from the residence nor could the lender foreclose on the property for a period of 60 days. The logic behind the moratorium was that a large number of Americans were being put out of work due to the COVID-19 pandemic and the last thing government officials wanted to see was a bunch of people being kicked out of their house during a period of time where the vast majority of the country was under some sort of “stay at home” order.
Although the original intent of the order was noble enough, the unwinding of the action has been problematic to say the least. Since that announcement, the moratorium has been extended twice (see Milton Freedman’s opening quote) and currently runs through the end of the year due to the perception that lifting the order would trigger a wave of defaults, foreclosures, and evictions. Unfortunately, extending the moratorium does little to fix the underlying problem of many tenants and homeowners simply not having the financial means to make good on their obligations and is instead just kicking the can down the road while further compounding the financial losses.
This fact is not lost on the FHA who recently announced an Adverse Market Refinance Fee (AMRF) to help offset an estimated $6 billion worth of COVID-19 related losses on their balance sheet.
The AMRF adds an extra fee to sell a mortgage to either Fannie Mae or Freddie Mac. Since most banks are in the business of originating and servicing loans rather than keeping them on their own balance sheet, it has become commonplace for most loans that meet the FHA requirements of size and credit worthiness (e.g. conforming loans) to be sold to either Fannie or Freddie.
The new fee amounts to an extra 0.5% of the refinanced mortgage. As an example, a $300,000 refinanced conventional mortgage will now cost an extra $1,500 to close. Although the extra cost is being paid by the bank to the FHA, it will simply be passed on to the consumer. The new fee was originally announced on August 12th and was set to take effect on any refinanced mortgages delivered to Fannie Mae or Freddie Mac after September 1st, but due to wide spread industry backlash, the start date has been pushed back to December 1st and some loans for lower income individuals have been carved out.
Coming out of pocket to cover thousands of dollars of closing costs can be problematic for many borrowers. To avoid this pitfall, many lenders are simply raising their interest rates to cover the additional expense rather than increasing their closing costs. In the same way individuals can pay more up front to lower the interest rates, taking a higher interest rate reduces closing costs through lender credits. In rough terms, for every 0.25% change in the interest rate, there is a charge (rate down) or credit (rate up) of roughly 1% of the loan value. For example, if the market rate on a $300,000 mortgage is 3.0% where the borrower covers all the closing costs out of pocket, the borrower has the option of coming out of pocket an extra $3,000 (1% of $300k) in order to lower the rate to 2.75% (0.25% below market) or can get a $3,000 credit toward their closing cost by taking a mortgage for 3.25% (0.25% above market).
Since the banks have decided to pass this cost along to borrowers in the form of a higher rate rather than extra closing costs, the end result is a worse deal for those that keep their mortgage for a long time. Many industry experts are estimating that the new AMRF will add between 0.125% - 0.375% to the interest rate, which means a 30-year, $300,000 loan will end up costing the borrower close to an additional $15,000 in interest (using the mid-point estimate of a 0.25% increase in the rate) if held for the full 30-year term, which is 10x more than the extra up front cost being charged to the bank (0.5% * $300,000 = $1,500). Generally speaking, the break-even point for baking costs into the rate rather than paying them up front is right around 2 years, so if you plan on having your mortgage for longer than that, you would be better off coming out of pocket than taking a higher rate to cover up-front fees.
One last thing to clarify. Although the start date for AMRF has been pushed back to December 1st, this is the cut-off of date for refinanced mortgages to be delivered to Fannie Mae or Freddie Mac. Given how backed up many lenders are with refinance activity, it is not uncommon for it to take 45-60 days to complete the process, which means the window of opportunity to avoid the AMRF is quickly closing. What we are seeing in the market place is that some lenders are already baking this new fee into their rates, while others are not because they are confident that they will be able to close and deliver the mortgage in time. The screen shot below was pulled from bankrate.com today and shows the wide dispersion of rates with and without extra closing costs. Comparing the two highlighted “zero point” options we see that the difference in rate being offered is a full 0.375%!
In conclusion, with rates hitting all time lows and extra fees going into effect that will push rates up, there is no time like the present to consider refinancing your mortgage. Maybe AMRF is temporary and there will be plenty of opportunity in the future to lock in sub 3% rates on a 30-year mortgage, but again, I will refer to Milton Freeman’s opening quote. For clients of the firm, we are happy to assist in this decision and facilitate the process by connecting you to a lender and compiling your financial information for the application.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.