During this period of prolonged artificially low interest rates, 80% of loan applications submitted nationwide
are for a refinance. This financial adjustment may be a prudent decision for the well-informed homeowner who has an
equity in his property, but the majority of Americans are relying on the risky calculations of financial advisers
looking to profit from homeowners’ ignorance.
Hundreds of financial planning websites have sprung up offering broad, hasty recommendations for a decision that
requires a specific, thorough understanding of each individual’s circumstance. Refinancing generally costs anywhere
from 3% to 6% of the outstanding loan principal — a major undertaking that is not to be casually entered into
without a proper due diligence investigation.
Many banks use these “refi calculators” as lead generators, connecting potential borrowers to over-zealous
banks. They use the “1% rule,” telling homeowners refinancing is an invariably prudent option so long as it knocks
at least one percentage point off their current interest rate.
However, this reductionist conclusion neglects the necessary comparison of a homeowner’s monthly savings to the
closing costs for the refinance — a fact which may suggest a refinance won’t ultimately save much, and may even
lose money for the homeowner. An intelligent decision must also take into account a homeowner’s tax rate, inflation
expectations and how long they plan to continue occupying their home. Thus, the one-size-fits-all calculations
provided by the online refi calculators are uselessly generic at best, misleading at worst.
The National Bureau of Economic Research (NBER) uses a
formula that more accurately reflects a homeowner’s refinance options, and honestly reflects when a refinance is
not in the best financial interest of the homeowner. The government algorithm compares the loan size, the
homeowner’s marginal tax rate, the expected inflation rate over the term of the loan and how long the homeowner
plans on staying put – the factors necessary to make an informed decision, one way or the other. Not
surprisingly, the government calculator offers a more lucid snap-shot of a homeowner’s options, often suggesting
a refinance is advantageous only if interest rates get lower.
Clarion's take: Agents and brokers need to aggressively encourage homeowners to seek free
counseling from a housing finance agency approved by the Department of Housing and Urban Development (HUD)
before making any refinancing decisions.
Agents and brokers can also educate the community by addressing the refinance frenzy in FARM letters, financial
planning seminars and through sound counseling with homeowners considering a loan modification.
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