If you had a mortgage at 6.5 percent interest and had a chance to slash your interest rate in half, you would say where do I sign? Right?
Such a scenario unfolded, and more recently than you think. When rates hit a rock-bottom rate of 3.35 percent in 2012, refinancing a $200,000 mortgage from 6.5 percent to the lower rate would have saved you $130,000 over the life of your new loan.
Many lottery winners don’t even keep that much loot after paying taxes and their relatives off!
But here’s the kicker, a new refinancing study reveals that homeowners leave thousands of dollars on the table every year, regardless of how low rates fall. By failing to refinance, they forgo real savings that could have gone to remodel a kitchen or bathroom, start an education fund, kickstart a retirement account, pay down credit cards and consolidate other outstanding debts, launch a business or take a much-need vacation.
I mean, who can’t use free money?
Such a failure to respond to such an obvious opportunity caught the attention of academia, including professors Benjamin J. Keys, Harris School of Public Policy, University of Chicago; Devin G. Pope, Booth School of Business, University of Chicago; and Jaren C. Pope, Department of Economics, Brigham Young University. They even published a paper on the intriguing phenomenon, “Failure to Refinance.”
Without going into too much detail, these academics hypothesized that if housing represents about two-thirds of the median household’s total wealth, homeowners would do everything they can to protect that investment.
To test their assertion, they distilled data (some 1.5 million single family mortgages) furnished by CoreLogic, screening out those with low credit scores, too high loan-to-value (LTV) ratios, sinking equity and other negative factors. Yet, after all that, they still found that roughly 20 percent who would have benefited from refinancing, didn’t take the plunge.
CoreLogic was so impressed with the professors’ work that it awarded them its Academic Research Council Excellence Award. Those who could have refinanced but did not weren’t rewarded at all.
But as impressive as the professors’ data-sifting was, it only confirmed what has long been known. Many people who can refinance simply fail to do so, missing the opportunity of a lifetime or at least 30-years of paying a smaller mortgage. If you’re someone who might benefit by refinancing, use the MyBankTracker mortgage calculator to figure your savings.
Small percentage of homeowners participate
When the Treasury Department launched the Home Affordable Refinance Program (HARP) to help more borrowers refinance — even those with high LTVs — it predicted some 4 to 5 million people would access the program. Less than a million did, a trend right in line with what the professors discovered.
The professors also partnered with the Neighborhood Housing Services of Chicago (NHS) to try to get at the core of why more people weren’t refinancing. NHS is a much admired nonprofit pro-housing advocate dedicated to expanding housing opportunities for underserved, lower-income communities. Encouraging its clients to refinance when rates head lower is an important part of NHS’s mission.
On three occasions, NHS mailed letters to households determined to be most likely to benefit from refinancing. Each letter coincided with a subsequent drop in interest rates. Each letter promised that no upfront money would be required from the borrower to refinance.
After the first letter was mailed in July 2011, 84 percent did not respond. On average, the 16 percent who did paid $24,500 less in total interest payments over the life of their loans.
NHS mailed a second letter in July 2012, addressing many of the same borrowers it had targeted in the first mailing. The impetus for the second mailing was clear. Rates had fallen substantially more to 3.99 percent. Yet, 75 percent did not respond, resulting in missed savings of $24,700 per homeowner.
NHS mailed a third and final letter in May 2013. This time only 13 percent responded.
A confluence of explanations and excuses
As behavioral economic scientists, the professors collaborated with NHS on a telephone survey of those who had received the NHS’s direct mail pieces urging them to refinance. About a quarter of the respondents said they never opened the letter. Of those who did, about one-third said they intended to follow up but never did; another one-third said they determined that the savings weren’t significant enough, and another third said they were now sufficiently interested and would talk to a loan officer.
After reviewing their data and listening to the respondents, the professors observed that although homeowners with lagging education, income and credit were less apt to refinance than those better off in those areas, the differences were small. Procrastination also held people back from refinancing. Myopia, or the lack of ability to envision long-term savings, and the inability to understand complex decisions were other factors cites.
“We came away with the view that it’s hard to move the needle when it comes to getting people to refinance,” said Professor Keys. “Even after the process has been streamlined for people and they have been 100 percent approved for a refinance, it’s still hard for them to pick up the phone.
“There are a confluence of informational and psychological factors contributing to this and they’re not easy to untangle. Among these is a lack of a trust in a financial system by homeowners who saw how their neighbors were treated in the real estate crisis.”
Keys further noted that some homeowners feel uncomfortable and unfamiliar with making the kinds of financial decisions that refinancing often requires. “It requires them to overcome a different set of barriers,” Keys added.
The street-level view
Although Kevin Hodge, a loan officer with The Federal Savings Bank in Baltimore, Md., had no knowledge of the study, he said he could clearly pinpoint the reason why more people don’t take advantage of refinancing.
“People feel there’s simply too much documentation required nowadays,” he said. “When I ask them for their W-2s, bank statements, tax statements, verification of employment, they see it as a real pain. They feel put off and overwhelmed by the whole process.”
What’s more overwhelming, however, is just how much money is being left on the table by consumers who could sorely use it.
“For those willing to chase down the paperwork, there’s a sizable reward waiting for you,” Hodge said.
Added Professor Keys: “We’ve all received the personal finance advice on how to save money by skipping our Starbucks lattes. But that’s a drop in the bucket compared to what people would save by refinancing.”Related