When a world altering event such as the COVID-19 public health crisis rattles the world economy, there are unpredictable consequences. Supply chains continue to be strained, leading to empty shelves and car dealerships. Generous government pandemic assistance worsened inflation, causing it to spike to levels not seen since Stephen Spielberg’s “Raiders of the Lost Ark” was the highest grossing film of the year. Russia’s war on Ukraine not only unleashed untold human suffering, but also elevated fuel prices. So, while many rushed to take advantage of historic low interest rates and increasing home equity, is it still a good time to refinance your house under the current economic conditions?
Indeed, the U.S. Bureau of Labor Statistics states in an April 12, 2022, Consumer Price Index release that the gasoline index rose 18.3% throughout March whilst inflation rose across the board. “The all-items index continued to accelerate, rising 8.5% for the 12 months ending in March, the largest 12-month increase since the period ending December 1981,” the report states.
Inflation, once deemed transitory, hasn’t abated as hoped. To tamp down on spiraling prices, the Federal Reserve approved a 25 basis point interest rate increase during its March meeting. Then, during an International Monetary Fund panel on April 21, 2022, Jerome Powell, chair of the Federal Reserve, indicates that a more aggressive approach may be necessary. “I would say 50 basis points will be on the table for the May meeting,” he says.
Higher interest rates mean borrowers end up paying more on a loan than they otherwise would have. While rate hikes have impacts that ripple across the whole economy, one of the major sectors it affects is the mortgage industry, where most Americans borrow money for one of the largest purchases in their lifetimes.
Nevertheless, the current federal funds rate of .33% is lower than the 1.58% rate of February 2020, right before the pandemic started its march across the U.S. and the Fed lowered rates in response. That said, is it still a good time to refinance a mortgage, and how do these changes affect the red-hot housing market?
A strange asymmetry became apparent in the early days of the coronavirus’ spread. Businesses that rely on crowds, such as concert venues and movie theaters, found themselves in dire straits, whereas online services such as Zoom and Amazon boomed. A combination of basement-level interest rates, the proliferation of remote work and the desire to avoid dense cities led to a frothy mortgage market.
Aaron VanTrojen, CEO of Geneva Financial, says that the health of the sector was uncertain at the beginning of the public health crisis.
“When the pandemic hit in March of 2020, it almost bankrupted the entire mortgage industry,” he recalls. “After the federal government passed the CARES Act, it essentially made mortgages worthless to investors. And so overnight, something that was very profitable, was not profitable. In fact, it cost money to fund loans. It almost wiped out the mortgage industry.
“Luckily, the federal government realized their errors and fixed the CARES Act,” VanTrojen continues. “That turned it into probably the most profitable two years in mortgage history. Every single homeowner had the ability to refinance into lower rates, home prices surged and buyers flooded the market. So not only did we have a huge uptick in refinance activity, we’ve also had a huge uptick in purchase activity.”
Meeting this demand was as difficult as it was unexpected. Greg Thorell, senior vice president of residential lending for Arizona Federal Credit Union, says that he had enough staff to handle 200 loans during the onset of the pandemic.
“At one point, I had 450 [loans to service],” he says. “Hiring staff at that time was extremely challenging. You would essentially have to pay hiring bonuses and overpay in some respects. I’ve never been a manager to over hire, and then have to cut staff. So, we sucked it up for about a year, and it was pretty rough because we had so much volume.”
As with any expansion, the pace inevitably loses speed before there is a contraction. For the mortgage boom, Lisa Davey, vice president and Northeast Arizona retail division manager at WaFd Bank, says that the high-water mark was reached somewhere between summer 2020 and summer 2021.
“It’s been a great couple years for the bank, and it has hardly slowed down. When rates were as low as they have been, everybody and their mother refinanced at least once, if not twice. Many people did home improvement projects during the last couple years, and that was a driving force too,” she notes. “The refinance market is slowing down quite a bit, because we’re seeing a huge influx in construction lending. It seems like that’s all the loan requests that we’re getting.”
The clock is ticking
As interest rates start to climb back up, the procrastinators and Johnny-come-lately-types might see that a window of opportunity to save money each month closing. Is it too late to refinance?
“I’m going to stop short of saying anyone has missed the boat,” says Ken Bauer, chief lending officer at OneAZ Credit Union. “If you take rates right now and put them in a historical context, they’re still really, really low. If you look at those rates compared to the last two to three years, they’ve come up a little bit — but they’re still not bad. I cannot imagine we’re going to see rates like we did from November and December of 2020 again.”
Whatever rate a homeowner currently has and how long they plan on staying in their house also affects the calculus, but Bauer thinks many borrowers can still benefit from a refinance. “There are still plenty of people out there who have sat on their hands a little bit too long. And sure, they missed the lowest of the low, but they still need to think about it,” he says. “Generally speaking, if you can save a half percent on your rate, you need to refinance — there’s just no reason not to.”
Bauer adds that he’s started to see people who wished they would’ve acted sooner on a refinance to save more money on their mortgage payment. “I’d rather see someone save $100 a month, even if they could have saved $400 had they done it six months ago,” he says.
Though not everyone is just looking for a better rate, Thorell notes. “People refinance to get cash out and accomplish different things — you have another child, you need to do a remodel or one of the one of the wage earners decides to stay home to care for children,” he says. “You might refinance to consolidate debt to make it easier for your cash flow. That’s not necessarily a rate-driven decision. The rate term refinance markets have slowed considerably, but there’s opportunities for people to do things they want to do.”
Another aspect a borrower should consider when mulling over a refinance is where they are in the amortization schedule. Part of each mortgage payment goes to interest and the principal balance. Early in the life of the loan, the vast majority of each installment goes to interest, but further down the amortization schedule, the ratio starts to include a larger portion of the principal.
“If you’re in year seven or eight of a 30-year fixed mortgage, every monthly payment that you’re making is chunking down a pretty good amount of the principal balance that you owe on the mortgage. And if you refinance, that amortization table starts all over,” explains Trevor Halpern, CEO of Halpern Residential at North&Co. “Yes, your monthly payment is going to be less, but you are now going to incur a far larger total dollar amount being paid to the bank in interest.”
Those tuned into the housing market have seen stiff competition typified by voracious demand and dwindling supply, leading to rising prices. Zillow Research’s March 2022 Market Report notes that the typical U.S. home is worth 20.6% more than it was one year ago. It also shows a slight rebound in Phoenix’s for-sale inventory, with March 2022 posting a 6.4% month-over-month increase — yet is still down 9% year-over-year.
With interest rates on the rise, some homeowners may reconsider plans to sell, further reducing available inventory. “With the market right now, where prices have really escalated quickly over the last year or two, everything’s more expensive,” says Joel Johnson, East Valley market president for FirstBank. “If you combine the additional expense of the purchase price with a higher interest rate, that can greatly increase your payment. So, I do think people are going to stay put a little bit longer in their houses and take advantage of that comfortable payment they got from refinancing within the last couple years.”
While it has been a cutthroat market looking for a house, those searching for their first home are acutely impacted. “The reality is higher interest rates absolutely have an effect on people’s ability to qualify for homes — especially first-time homebuyers,” Halpern notes. “Typically, they don’t have a ton of cash laying around for a down payment, and don’t have the value of turning the equity that they built in a previous home into a down payment on the next one.”
Moreover, without equity to use as a down payment, aspiring homeowners are left with a larger initial mortgage balance and more interest to pay. Halpern adds that the general rule of thumb is that for every 1% interest rates go up, the consumer loses 10% or more of their buying power, because so much more of each monthly payment is going to serve that debt.
“If you were coming into the marketplace to qualify for a mortgage a year ago, you were qualifying with a 2.8% or 3% interest rate. Today, you’re qualifying for 5%,” Halpern concludes. “Guess what? That loan is costing you 20% more now. Put that on top of the fact that the same home that you could have bought two years ago is now 25% more expensive, the value proposition — the effective total combination of the actual list price plus the interest that you’re paying — has shifted to where that house is costing you 30% to 35% more than a few years ago.”