Now is generally the best time to refinance

There is a game played in the financial community: predicting changes in interest rate levels. This is a dangerous game to win but people always try, thinking they are smarter than others playing the game, or that this time, fate is with them and they will succeed. Without knowing the details, my guess is that fate is best left to the theologians and game players win no more than half the time. If so, economics is not a religion and a coin flipper will do just as well.

In real estate, the form of the game is often deciding whether to refinance an existing mortgage now or later. (The same game can be played when originating a mortgage — “now or later” —.) There is no doubt that significant savings are available if you can “time” this decision. The trouble is there is no evidence that one can predict (mortgage) interest rate changes from period to period. Yet the game goes on.

For example, a recent article by Carla Fried of Two Cents Edition (in CNNMoney.com, May 29, 2009) wonders whether now is the time to “lock in” a fixed-rate mortgage since rates increased about 25 basis points (.25%) last week. It appears that the fear is that rates are now headed higher because they went up last week. Carla writes:

“So what’s a floater [someone on the fence] to do now? Well, if you’ve lost your betting mojo, lock in and be happy. Yes, happy.  Let’s remember that 5.45% is still seriously good.  It was only one year ago that the average 30-year fixed rate was 6.1%. And long term, it is all but assured that a 5.45% fixed rate is going to look darn nice.” It is strange, indeed, to think that last year’s average has anything to do with future mortgage rates!

However, in the short run, Carla continues “well, that’s one big crap shoot … The big wildcard is Ben Bernanke and his merry band at the Federal Reserve. The Fed has been actively buying up long-term Treasuries and mortgage backed securities in an effort to keep yields low…” Yet, residential borrowers are not traders; they cannot predict what the Fed is doing or what the impact on rates will be.

Carla concludes: “The bet’s yours … lock in now … or put your money on the Fed pushing yields down …. Which way are you leaning?”

My take is decidedly different: since the evidence is overwhelming that it is impossible to predict short-term changes (period-to-period) in interest rates, you should not try to play this game. As a result, it is best to refinance whenever it makes sense to do so and not try to time the market. If you try to play the game, you are not likely to win more than half the time. Thus, do the calculations and if it is significantly worthwhile to refinance, do it before the advantage is gone.

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Tags: mortgage, refinance

This entry was posted on Tuesday, June 2nd, 2009 at 9:35 am and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed.