How to Structure the PERFECT Refinance in a Sea of Options

With the 10 Year Treasury yield (why this is important) crashing through 2% and hovering around 1.5% for weeks now, it’s an optimal time to exploit the lowest rates we’ve seen EVER (Rate Table).  However, there are so many dozens of different options to choose from ranging to terms to rates to closing fees, it’s tough to do an apples to apples comparison of what the best refinance option is for you.  Here are some of the criteria that were important to me and why I avoided some of the common refinance structures:

• No-Cost - Personally, I’ve been hesitant to part with thousands of dollars in closing costs even if the payoff seems to be there since I like to keep a cash buffer in my emergency fund and put my cash to work elsewhere.  For this reason, I’ve been continually monitoring No-Cost Refi Deals (make sure to read this to understand the difference between no-fee and no-cost so you don’t get burned), so I could have the best of both worlds – no cash out of pocket at closing AND a more favorable mortgage structure.
• Fixed Rate – Many people are in favor of snagging the lower rate 5/1 adjustable rate mortgages since they go as long as 2.5% and you can save big money each month if you’re paying something like 5% or more now.  However, with a conventional 30 year term in total, I worry about what happens after the initial 5 years if and when the rates increase.  Given that it’s unlikely rates could plummet further from here unless we’re truly Japan, the only direction is up.  Now, most ARM structures allow only 3 increases of max 2% each based on a key benchmark, so by year 8, your rate for the following 22 years could well be 8.5%.  That’s not terrible, but certainly not as good as just settling for something in the 3-5% range by avoiding the ARM structure.  If you think you have a decent chance of moving within the next several years, by all means, go for it, but I’m not into a short ARM.
• Shorten My Duration WITHOUT a Higher Monthly Payment – I could have easily gone into a 15 year mortgage from my current 30 year term for a lower rate, but most of the benefit is actually derived from the shorter term and the rate barely matters when you’re moving from a 4.625% on a 30 like I am.  (try this out in a mortgage calculator and you’ll see, at the 15 or even a 10 year mortgage, changing the rate doesn’t change the payment much since the term is so short).  On one hand, I would have liked to have decreased my total mortgage term by quite a bit, but I’m not a big fan of pre-paying mortgages or going into a 15-year due to the present value of money.   I showed here how even a 3.25% rate made no sense for me mathematically (you’ll be shocked why).  I wanted to avoid a 50% higher mortgage payment a 15-year brings in the event of job loss, emergency or opportunity cost.  I also didn’t want to get into a cycle of continuously refinancing the same 30-year mortgage so the thing’s never paid off.  Presently, I’m about 3 years into a 30, so I have 27 years left.  Could I get the perfect mortgage?  Yes
• The Perfect Refinance for Me – Here’s the solution I came up with.  I identified a No-Cost Refi Broker, got a 3.75% rate on a 25 year mortgage (yes, this rate is slightly higher than the market rate for a 25 where you can find them, because I’m paying nothing out of pocket!  While I might pay a few grand extra over the life of the loan, it’s a no-lose for me now).  This rate also includes no escrow since I hate paying all that cash up front and extra monthly payments as opposed to simply paying my tax and insurance bills once per year when they’re due (again, the present value of money).  I can accomplish all criteria with this loan: a) Nothing out of pocket b) Lower Monthly Payments (saving like $80 per month) c) shaves 2 years off my old 27 years remaining d) fixed rate (never have to worry about interest rate risk).  

Of course, this may not be the perfect mortgage for you, but using some simple excel spreadsheets and carefully weighing the options (I also always consider the hypothetical scenario of just leaving the present mortgage and pre-paying or doing nothing, but this option clearly wins out), I feel I’ve landed on the perfect refi.  I somewhat considered going to a 20 year to shorten up that term, but then my monthly payments increase a bit.  Its only $123 or so, but one of my goals was to REDUCE my monthly payments, not go up in cost.  As long as you’re evaluating what your actual goals are, eliminating options that do not conform to those goals, comparing apples to apples on the best rates in that structure (Full Rate Table Here), you might have a Eureka moment like me!

What Are Your Perfect Refi Criteria?

Have You Achieved the Perfect Refi?