A Lender’s Tale — Re-financing Real Estate in Q2 2022

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Photo by Volodymyr Hryshchenko on Unsplash

TL:DR — Many banks are flush with cash, and rising rates changes the environment for all of us. Use your leverage to find the best credit possible.

Last week, the Federal Reserve indicated that the baseline Fed Funds rate will be increasing to a target range of 0.75–1.00 %. This baseline is the fundamental rate that many other lending rates are built upon in the US and abroad.

The intention of this piece is not to discuss the policy decisions or actions by the Federal Reserve…rather to show how the Fed impacts my real estate journey.

Mortgage rates, car loans, personal loans, business and commerce loans can all be built off of the environment that the Fed Funds rate sets.

At the basic level, Fed Funds rate sets the “risk-free” return for money put into debt. Banks borrow against this interest rate, and charge a higher interest rate, known as “spread”. The Fed Funds rate has been near 0 since COVID locked down much of the US in March 2020. Banks could then offer lower rates to customers, because their cost of funds was so low.

A loan to a borrower for a 30-year mortgage at 3.0%, funded by near-0% debt gives the bank a 3% return on their loan.

As rates rise, the banks maintain their spread above what their cost of funds are. A 1% increase in rates means that in general, debt costs to borrowers will also increase at least 1%. I say “at least” because a rising rate environment implies that the future will be riskier than the present or past…some lenders may go more than 1:1 on rate increases, to compensate for risk.

We’ve seen record low rates in recent years, but it hasn’t always been that way. October 1981 featured a Federal Funds rate of 15%, and the 30-year mortgages were priced at 18.4%.

A generally increasing interest rate environment could imply that credit is riskier and will be more difficult for consumers to acquire. The Federal Reserve, in a sense, is indicating that risk into the future should be priced a little higher than it is now…that money at risk should return a more commensurate rate with the environment.

And everyone builds off of the Fed’s opinion.

The original plan was to complete my house renovation and cash-out the equity increase through refinancing a mortgage. My original mortgage rate was 3.375. Today, mortgage rates are 2–3% more than that. We’ll assume that the best rate I could get today is 6.125, not quite double my original rate.

A nearly-3% higher mortgage means I’d pay $414 more dollars in Principal & Interest. That’s enough to make a deal a no-deal.

My plan isn’t going to work in the way I thought it would. I’ve got to pivot.

The cash-out-refinance likely isn’t going to be the play anymore. Taking on a new mortgage at a higher rate cuts into my margin dollar-for-dollar.

Banks tend to like rising rate environments, because the total rate they can charge is higher, meaning the total interest accruing is higher. Their spread might stay roughly the same, but their pie gets bigger. Playing with percentages can get tricky, and that’s outside the scope of this piece.

Banks right now are more than willing to lend. They are flush with cash from higher savings rates and government surplus since COVID. Interest rates are rising, so they’ll seek better earnings on new debt at higher rates, even if their spreads remain roughly the same. Housing supply is short in many parts of the country, so loan volume has decreased dramatically, and prices have shot up.

Combine those factors, and you get banks that will likely be competitive with each other to take on new borrowers.

How this helps me: I have a HELOC with one bank. I need them to increase the limit on my line.

If they don’t, I’m confident that in the current credit market, that I’ll be able to find another bank or credit union to take on the risk of my debt. Banks right now are going to be competitive with each other. Especially in real estate.

Now that volume has dropped (~80% by anecdotal mortgage industry insider), lenders aren’t doing as much business as they have in the prior 2 years. Combine that with rising rates and extra cash on hand, and you get competition for borrowers.

Banks don’t want to sit on excess cash reserves that don’t make any money…they want to get it out there to earn a return.

So if my current lender isn’t willing to play ball. I’m betting I can access those additional funds elsewhere.

Future updates to come.

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