With everything the economy has been through these last few years, interest rates have hovered at historic lows – but they won’t stay this low forever. The Federal Reserve (a.k.a. The Fed) uses interest rates to influence the economy in a positive direction. When it’s time, rates will begin to go back up again.
That could be good for your savings accounts because you’ll finally be able to earn some interest! But what about a mortgage? High interest rates mean you pay more interest on your home loan (and who wants that?!).
If you’re wondering and worrying whether you should refinance your mortgage now, before interest rates go back up again, here are some answers to help you decide.
What’s Ahead:
Refinancing: why rates matter
The interest rate on your mortgage determines how much interest you’ll pay on your loan in addition to the principal amount you borrowed. The higher the interest rate, the more you owe your lender.
Take an example: say you borrow $300,000 to buy a home, and your mortgage rate is 5% for a 30-year loan. You’d wind up paying $579,000 over the life of the loan!
But if you had an interest rate of just 3%, your total outlay would be about $455,000 – almost $125,000 in savings. That’s why mortgage rates are important, even though a difference of 2% seems so small. It could mean a savings of thousands of dollars a year. Wouldn’t you like to have thousands of extra dollars a year?
Try MU30’s mortgage calculator below to get an idea of how different figures can affect your outcome.
Breakeven number
But there is one more thing to consider with refinancing: the costs of taking out a whole new loan. As you might remember from buying your home, there are many fees, charges, and added costs when you take out a mortgage. These are called closing costs, and they are the cost of doing business and closing a loan of that size. Take a look at some average closing costs:
- Title insurance — $1,300.
- Title search fee — $100.
- Appraisal fee — $400.
- Attorney’s fees — $2,500.
- Loan origination fees — $2,000.
- Broker fees — $2,000.
- Paperwork or processing fee — $100.
- Points (or “discount points”) — $1,000.
Altogether, these fees can cost thousands — easily 3% or even 5% of your total home cost.
While you may not pay all of these fees again when you refinance, you will still incur fees and charges in addition to the loan amount and interest.
You have to take these extra costs into account when figuring out how much a new loan will cost and when you will “breakeven” – when the new loan will start saving you money.
To find your breakeven number, take the amount of your closing costs and divide it by the amount you’ll save per month with your new loan. That’s the number of months it will take to break even on what you spent taking out your new refinance loan.
For example, say you expect to have $4,500 in closing costs, and you’ll save $150 per month by refinancing. 4,500 divided by 150 is 30. So it would take you about 2 ½ years until you recouped your expenses on your refi.
Refinancing pros & cons
Keep that concept of “breakeven” in mind as you decide whether it’s a good idea to refinance now to take advantage of low interest rates. It will help you as you are considering the pros and cons of refinancing.
Pros
Finding a refi with great terms should save you money over the long term:
- You could get a better interest rate.
- You could lower your monthly payment.
- You could decrease the amount of interest you pay.
- You could find a loan with better terms.
- You could drop PMI (private mortgage insurance) if you have enough equity.
- You could pay off your home sooner.
- You could consolidate your debt.
Cons
However, the cons of refinancing should not be ignored, especially the costs in the short-term:
- You’ll pay closing costs all over again.
- You might not be able to afford to pay closing costs out of pocket.
- You’ll “reset the clock” on your mortgage, giving you 30 more years of payments (unless you choose a 15-year loan).
- You could lose out on savings, or even lose money, if you move before your breakeven point.
- You could ding your credit by the “hard pull” on your credit report.
Why it could be a good time to refinance
Your personal situation has a lot to do with taking advantage of a refinance. If your situation has improved, you could have good reason to refinance your house.
The rates are too good to pass up
With the COVID-19 pandemic, mortgage rates have hit historic lows – touching just 2.65% in January 2021, for example. While rates have gone up a little since then, you might still be seeing rates much lower than what you were able to get when you purchased your home.
With the exception of 2018, when the average home loan neared a 5% interest rate, home loan rates on 30-year mortgages have averaged under 4% for about 10 years. But your own mortgage rate could be higher or lower than that, depending on the loan terms you qualified for when you bought the home.
A good rule of thumb is that it can make sense to refinance if your existing mortgage rate is at least 1% lower than new mortgage rates – 2% is better. You’ll still have to run some numbers, but this is a ballpark to get you started.
To find out the best rates in your area, check out the table below:
Your credit score has improved
If you’ve been working hard to improve your credit score, congratulations! It could really start to pay off! A good credit score often brings better interest rates and better terms on a loan.
You’re making more money
Another reason for congratulations! If you are earning more, you might be able to afford to refinance from a 30-year mortgage to a 15-year one. Your monthly payments might be a little higher, but the whole house will be paid off in half the time.
Plus, interest rates on 15-year loans are usually less than those on 30-year loans.
You’re making less money
On the other hand, if you’re bringing in less money, a refinance may be able to help.
Refinancing gives you the ability to potentially lower your mortgage payment and give you a little more room in your budget. (P.S. the refinance process works on student loans, too. Check out Credible, a loan company that does refinancing. They’re a great option when you’re in a pinch and need to reassess your finances).
You need the cash
Whether your family is expanding and you need more room, or that Mad-Men era kitchen just isn’t cutting it anymore, a refinance gives you a way to fund home repairs and renovations. You may be able to afford your intended renovations just with the money you save from a refi, or you might even want to do a “cash-out” refinance, which provides you a larger loan you can use to pay for improvements.
You’re not planning to move for a long time
If you know you’re going to be in your home for years and years, refinancing can make your mortgage work better for you. You also know that you’ll be around to take advantage of the savings when they kick in after your break-even point.
You’ve gained a lot of equity in your home
Hopefully, your home has appreciated in value since you bought it. If you now have 20% or greater equity in the home, you could refinance to take advantage of that appreciation. You could use the refinance to drop private mortgage insurance and recoup that expense each month, or you might do a cash-out refi to help cover other costs, such as consolidating debt.
Why you should wait to refinance
Now that you have an idea of some incentives to refinance, check whether you need to put on the brakes. If the following apply, you might want to wait to refinance.
Rates are going back up
If current rates are too close to what you have now – say, within less than 1% – it may not be worth it to refinance, due to the other costs you’ll pay for taking out the new loan.
You can’t afford to close
You may really have your heart set on a lower mortgage payment, but keep in mind you’ll have to be able to afford the closing costs. Depending on your loan, those might need to come out of pocket. Do you have thousands of dollars sitting around that you can throw toward closing costs?
You’re deep into your mortgage
If you’ve been in your home for a good while, you’ve actually started paying down that mortgage. Resetting the clock by taking out a whole new 30-year mortgage might actually set you back from your progress. Imagine if you’ve already paid, 2, 5, even 10 years or more on your home – only to turn around and push your payoff date 30 more years in the future. You could wind up paying on your home for far longer than 30 years in that case.
How long will mortgage rates stay low?
Sure, loans are cheap now – but will they stay that way? If you’re trying to time your refinance, you may want to think “sooner” rather than “later.” Although experts predict rates will stay relatively low for a while, the economy is expected to recover from the pandemic, at least somewhat, in 2021, and there is a lot of optimism for a rebound.
As vaccines become more widely available, the virus is held at bay, and businesses reopen more fully, the economy may improve – and that could mean more jobs, better pay, and higher interest rates.
While mortgage rates may stay low enough to make buyers excited, they may not stay quite low enough for a refinance to make financial sense. One prediction, from the Mortgage Bankers of America, estimated a rise to a 3.6% average interest rate by the end of 2021 – certainly a good deal for homebuyers, but perhaps not as incentivizing for refinancers. By the end of the fourth quarter of 2022, MBA predicts rates could rebound as high as 4.5%.
If you can find a much lower rate now, you might be better off acting now instead of waiting, when rates move toward where they had been before the pandemic hit.
Summary
If the timing is right for your situation, taking advantage of historic lows for home mortgages could save you thousands on your home loan. But interest rates are not the only factor in deciding whether it’s a good idea to refinance.
No matter what current interest rates are, you have to weigh the time you’ve been in your home, how long you plan to stay, the costs of closing, and the potential savings to see whether a refinance would work out in your favor.
If the math adds up, then go for it! Enjoy your new home loan and the peace of mind you’ll receive knowing you got a great rate.
And if a refinance is not in the cards for you, don’t worry. You can still pay extra on your home loan for a similar effect. Whether you choose to make extra payments throughout the year, one extra lump sum payment, or a little bit extra on your regular monthly mortgage payment, you can still decrease your debt and pay off your home sooner!
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