Refinance in Anticipation of Sale?

May 30, 2011

Homeowners who anticipate that they will be selling their house within a few years want to net as much from the sale as possible. I use the verb “net” deliberately to indicate that what matters is not how much they receive for the house but how much they have left after repaying the mortgage.

Real estate agents counsel borrowers on ways to get the best sale price, such as repairing obvious defects, keeping the house sparkling clean for potential buyers to view, and so on. I don’t have anything to contribute on that topic.

But some owners view an impending sale as a way to save money on the mortgage if they can refinance into a lower payment, and I do have something to say about that. The borrowers who do this often ignore the impact of the refinance on the size of the loan balance that they will have to pay when they sell. Here is an example.

The current balance on a 4.125% mortgage is $300,000, payment $1685 with 23 years remaining. The borrower expecting to sell in 2 years refinances into a new interest-only ARM at the same rate, reducing the payment to $1031. The refinance cost is $6,000, but the borrower reduces his payment by $654, which over 2 years sums to $15,696. Hence, by his logic, he is ahead by $15,986 minus $6,000, or $9,986.

What he has overlooked is that if he had stayed with his existing mortgage, he would have paid down the balance by $16,307, which would have resulted in net proceeds at sale $16,307 larger. His supposed gain of $9,986 is actually a loss of $6,321.

The bottom line is that a pending sale should not change the refinance decision process, which should continue to be based on a  comparison of the upfront costs of the transaction with the interest savings over the remaining life of the mortgage. The calculators that can be used for this purpose are at Refinance Calculators. What the sale does is shorten the period over which the benefit accrues, reducing the likelihood that the refinance will be profitable.


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