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MORTGAGE REFINANCING BOOM AND THE GENERATION OF RENTERS

Written by Ryan Kelly on 08/03/2019

Dropping Homeownership Rates

Homeownership rates slipped for 3 consecutive quarters as home prices continue to outpace wage growth. This has led to a generation of renters who continue to be left out due to a low inventory of affordable homes. Thus, when the 30 year fixed mortgage rate dropped below 4% in May and began to approach the lowest level in 3 years, the benefits have largely gone to existing homeowners, fueling a sudden boom in refinancing.

One Key Benefit of Homeownership

There is one key benefit of homeownership that the current generation of renters cannot take advantage of: leveraging wealth. Homes are one of the few investment vehicles where you are allowed to get a loan up to 80% of the purchase price (or even 96.5% for FHA, and 100% for VA loans). If home prices continue to rise, in a hot market such as Austin, Texas, this has a leveraging effect on your net worth. For example, suppose you buy a $300,000 house with a 20% down payment of $60,000. Next, suppose home value increases 10% in one year, to $330,000. You just achieved a 50% return rate, excluding interests and fees, on your original $60,000 investment due to the leverage effect ($300,000 x 10% = $30,000 / $60,000 = 50%). You must be a homeowner to take advantage of this. Renters, on the other hand, are squeezed out as rent continues to increase to reflect rising home values.

Why Have Rates Dropped?

Standard mortgage interest rates advertised by lenders are tied to economic activity. As a rule of thumb, when economic activity rises, mortgage interest rates also rise. Vice versa, when economic activity decreases, rates typically decrease. The latest drop in mortgage rates is a reflection of concerns for the US economy as trade tensions rise and global growth slows.

So why are mortgage rates tied to the economy? Lenders need to acquire funds to issue their loans. If you get a $300,000 loan, the lender needs to have $300,000. Bank loans are funded by bank deposits and non-bank lenders are funded by investors in MBS (Mortgage Backed Securities). The cost of acquiring these funds, either through deposits or investors, are highly dependent on the market and economic outlook. For example, in an economic boom, there is less incentive for depositors and investors to put money into lower-risk, lower-return vehicles such as bank deposits and MBS. Consumers spend more, businesses invest to expand, and investors seek high-risk, high-return investments such as stocks. Thus, lenders need to increase their rates to attract more depositors and investors

Is This A Good Time To Refinance?

The answer depends on your individual circumstances because economic activity is only one component of your mortgage rate. The final interest rate you will receive from a lender also depends on debt-to-income ratio (DTI), loan-to-value ratio (LTV), and credit score. Put in simple terms, lenders will give you lower rates if they think you have a better chance of paying back your mortgage. In the case of refinancing, the most important component will be your credit score. If you want to receive mortgage rates close to rates advertised by lenders, you will need to have a high credit score. If you think your credit score is good or has improved since your last mortgage application, we recommend that you view UpEquity's current best rates and fill out a refinancing application, as you may be able to lower your monthly interest payments!

Final Thoughts

If you think home values will continue to rise in your area and you are still a renter, we recommend you purchase a home in the near future. If you already own a home, consider refinancing if your finances and credit score have improved since getting your mortgage.

Sources

The Wall Street Journal, Boom in Refinancing Boosts Mortgage Lending, July 29, 2019
The Wall Street Journal, Financial Crisis Yields a Generation of Renters, July 26, 2019
The Wall Street Journal, Homeownership Rate Slipped in Second Quarter, July 25, 2019

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