The 10 Year Treasury and You

Consider Refinancing. Potential Savings: Thousands of Dollars or More. Difficulty Level: Moderate to High

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One of the biggest stories in financial news this year is the fall in long-term Treasury yields.[1]

The 10 year Treasury rate[2] has fallen from 2.7% at the beginning of this year to about 1.7% today, a steep decline and close to the lowest rate in history. For only about the 10th time since the 1960’s, long-term rates have fallen below short-term rates. Historically, this has been a surefire signal of an impending recession, but for various reasons beyond the scope of this email, maybe it isn’t.

Should this matter to you? Can you benefit from lower rates? One possible opportunity from lower rates is to consider refinancing your mortgage. If you’re like most American homeowners, you have a 30 year fixed-rate mortgage. Your mortgage interest rate is probably based on the 10 year Treasury rate plus a spread, as you can see from this relationship going back 47 years:

So, with 10 year Treasury rates near all-time lows, 30 year fixed-rate mortgage rates are near all-time lows as well. It may be worth considering refinancing your mortgage, if your current mortgage has a rate meaningfully above the refinance rates lenders are offering today.

15 year mortgage rates are even lower, and might be more attractive if you don’t have that much time left on your mortgage, if you intend to pay your mortgage off early anyway, or if you have a lot of financial flexibility. Make sure to shop around, not just with your existing lender![3] A recent survey of 30 year rates (clicking around on a random comparison website) showed a range of 150 basis points (1.5%) between the lowest and highest rates.

How significant must the savings be to make refinancing worth considering? There is no hard and fast rule, but some factors to consider are:

  • The upfront cost of refinancing, including all fees and “points” on your refinanced mortgage.

  • Your monthly savings from a reduced interest rate.[4]

  • How long you plan to stay in your home. The longer you plan to stay, the more favorable the numbers are likely to be.

Take any “rule of thumb” with a grain of salt. One popular rule that you should never refinance unless you can lower your interest rate by 1.5% or more. This rule is at best misleading and at worst plain wrong, in that it is usually designed to allow you to recoup the cost of refinancing in a year or two. If you instead plan to stay in your current residence for longer, refinancing could be worthwhile even at smaller decreases in mortgage rates.

For example (using some rough figures from the StreetEasy Mortgage Calculator - your math may vary):

  • Refinancing a $300,000 30-year fixed 4.25% mortgage to a new mortgage at 3.5% might cost $4,500 (assuming total refinancing costs of ~1.5% of the mortgage balance - it can be significantly more or less) and save you only $129/month on your monthly payment.[5]

  • But, in less than three years you have made back the cost of refinancing and anything beyond that is gravy.

  • Assuming you stay in your home for even a few more years, the implied savings on that $4,500 “investment” could be far higher than anything you could realistically earn on investing that amount in the stock market, with far lower risk.[6]

  • For longer periods, the numbers get much larger. For a $300,000 mortgage, over a 30 year period, reducing your interest rate from 4.25% to 3.5% on an otherwise identical mortgage yields a reduction in total payments of over $46,000.

While everyone’s individual situation will vary (and this is just a suggestion, not financial advice!), now is a good time to assess your own personal situation and consider whether refinancing could be an interesting opportunity. A lot of people seem to think so - recently, refinancing applications were up 169% year-over-year.

I hope this has been helpful. If you liked it, please press the “like” button and share it with your friends! Also, if there are any topics you’re interested in, please send me your requests. And finally, if one of these tips helps you, I’d love to hear about it - just send me an email and I may (anonymously, of course) mention your story in a future post.

Finally, a small disclaimer. This newsletter is not intended to be financial or investment advice, just interesting things I’ve come across that might be worth considering. Before making a big financial decision, you should consult your own accountant, investment adviser, or whomever you normally rely on for financial advice.

[1] Treasury bonds are how the US borrows most of its $16 trillion in national debt.

[2] Basically, the rate that the US pays on its debt due in 10 years.

[3] Of course, make sure to research any lender you’d consider using for a refinancing.

[4] It’s a bit oversimplifying to just compare monthly payments, because by refinancing into a new 30 year mortgage, your monthly principal payment will likely decrease (assuming your current mortgage has less than 30 years remaining). You need to compare the interest savings, and factor in taxes as well if you itemize deductions, particularly if you have a large mortgage.

[5] For simplicity, I’m assuming the original and new mortgages have roughly the same term. In reality, if you refinance from a mortgage with only, say, 20 years remaining into a new 30 year mortgage, your monthly payments will go down by more, but part of the reduction is only from stretching the principal repayment over a longer period. That isn’t actual savings. Only the reduction in interest reflects real savings.

[6] Again, this is an oversimplified example that ignores taxes, different mortgage lengths (if your current mortgage has significantly less than 30 years remaining), principal amortization, and many other factors. It’s just meant to be illustrative of the absolute savings over the length of two mortgages that are identical in all respects other than interest rate. So, you should do your own math as well!