With mortgage rates again on the decline, you may be considering a refinancing of your home mortgage. Instinctively, a borrower may be drawn to the 30-year fixed mortgage, seeing it as a great opportunity to lock in a low 4.5 percent rate for the duration of the mortgage. Under many circumstances, this is the right decision. However, for some borrowers, we want to get more creative.

Scenario 1 – Desire to pay down mortgage quickly:

Adjustable Rate Mortgages (ARMs) can work well for those borrowers who want to pay down their mortgage quickly. Since the interest rate is only fixed for a short period (3, 5, 7 or 10 years), the borrower assumes more risk that rates will increase during the life of the mortgage, and is typically rewarded for assuming that risk with a lower interest rate. If a borrower is in the position to pay off the mortgage, the risk of higher rates is mitigated.

  • The strategy here is to schedule the mortgage term with the timing of a cash infusion (sale of business, deferred compensation plan payments, etc.). The ARM has a 30-year payment structure and a low rate which minimizes the monthly obligation until the borrower’s cash is available to pay off the loan.
  • Amortize the mortgage over the short fixed-rate period instead of making the minimum scheduled payment. The additional monthly amount paid will directly reduce the mortgage balance.
  • 10-and 15-year fixed mortgages may also be good options for accelerating a mortgage payoff. The mandatory monthly payment will be higher than with an ARM because there is a requirement to pay additional principal. This mortgage structure does not provide much cash flow flexibility, which may or may not be a problem, given a borrower’s situation.

Scenario 2 – Jumbo loan (greater than $417,000 balance):

Jumbo loans are subject to higher interest rates than conforming loans ($417,000 or less).

  • Refinance a primary mortgage of $417,000 and obtain a home equity loan for the balance owed. The home equity loan will ‘float’ with the prime rate and can be subject to a minimum interest rate (4 percent is common). The obvious risk is that interest rates may turn up, causing the home equity loan to be undesirable. Therefore, it is wise to have a ‘Plan B’ strategy if it becomes necessary to pay off the loan quickly.

Scenario 3 – Cash needed for a large purchase:

If you are in need of cash for a large purchase, consider borrowing against the equity in your home. Loans for an investment property, new business, construction on a new home, etc., are more difficult to obtain and carry higher borrowing costs than traditional home mortgages.

Design an interest rate that best suits your needs

Many mortgage consultants will pay for the costs of refinancing (approximately $2,000 in Missouri). To recoup their costs, the loan will have a higher interest rate (typically 0.125 percent) which the mortgage consultant can sell to a mortgage buyer for a larger fee. If rates continue to decline, refinancing in the future will likely be appropriate and the no-fee refinancing could be less expensive overall. This strategy is also appropriate if you plan to maintain the loan only for a short time.

In many situations, mortgage consultants can waive the requirement to escrow the money needed for real estate taxes and insurance. To do so, the mortgage consultant will frequently add 0.125 percent to the interest rate, reflecting the additional risk the lender assumes should the property owner fail to pay their real estate taxes. For several reasons, a borrower may prefer to maintain control of the tax and insurance payments. Escrow is usually a large part of the monthly mortgage payment, so some borrowers prefer to minimize the monthly payment if taxes can be paid from another source of funds.

In my experience, borrowers usually dislike escrowing because they are frustrated that any interest earned on the escrow balance is not paid to them. However, under most circumstances, the better financial decision is to select the lower interest rate and escrow.

Before you consider refinancing—although the low rates may seem very attractive—make certain you understand the benefits and consequences of your decision. Your Moneta Family CFO can help you understand how your circumstances affect any refinance decisions.


Kara Harmon, CPA, CFP®, AWMA, CRPC

Kara is the professional consultant for Dave Sadler.