September 18th marked a major shift in monetary policy for the U.S. when the Federal Reserve announced it would finally start lowering interest rates.
Known as the Fed “pivot”, their first reduction was a whopping 50 points – cutting the federal funds rate down from the 5.25% – 5.50% range to 4.75% – 5.00%. Although half a percent doesn’t sound like a lot, it was perceived as a sign of optimism from the Fed about the economy’s overall health and suggested that future rate cuts would follow over the next few years.
As you might guess, this announcement has also caused mortgage interest rates to drop. In the weeks following the September Fed meeting, the 30-year fixed mortgage interest rate has fallen to a current national average of 6.08%.
It wasn’t all that long ago that if someone wanted to buy a home, they’d be looking at an APR (annual percentage rate) of 7 or 8 percent – even with good credit! This begs the question: Now that mortgage rates are falling, should I consider refinancing my mortgage?
In this post, we’ll explore a few of the reasons why refinancing does or does not make sense. We’ll also explore how much you could potentially save and if “right now” is a good time to act, or if waiting a little longer might be to your benefit.
What Does It Mean to Refinance Your Mortgage?
Simply put, refinancing your mortgage is the act of replacing your current home loan with a new one – usually with better terms. Even though most loans last 30 years, this doesn’t mean you’re stuck paying the same amount forever.
The process of refinancing is fairly straightforward. You’ll start by finding a lender. This can either be your current mortgage provider or a new company altogether.
Once you accept an offer to refinance, the new lender will pay off your current mortgage. From that point forward, you’ll make payments to your new lender under the new contract terms.
Refinancing is a very common practice in the debt industry. It’s done not just for homes but also:
- Auto loans
- RVs
- Boats
- Student loans
- Credit card debt
- Business loans
The Benefits of Refinancing Your Mortgage
Generally, the primary reason someone refinances their loan is to get a lower interest rate. The lower the APR, the lower your monthly payments will be.
However, there can also be many other benefits to refinancing besides how much gets drafted from your bank account each month. Here are a few others to consider:
- Shortened loan term – Want to pay off your mortgage faster? Many people opt to take a 15-year loan instead of a 30-year term when they refinance. The advantage is that more of each payment will go towards your principal. Plus, you can usually get a better interest rate.
- Change the loan type – If you started with an FHA or ARM (adjustable rate mortgage), refinancing gives you the chance to switch to a conventional mortgage.
- Eliminate PMI – Private mortgage insurance is typically assigned to any mortgage where the borrower puts down less than a 20 percent down payment. If you’ve made several payments and now own 20 to 25 percent of your home (or more), a refinance could be an opportunity to have PMI removed from your arrangement.
- Access to home equity – If you’ve got other high-interest debt such as credit cards, taking cash out when you refinance gives you the ability to pay it off by tapping into your existing home equity.
How Much Does It Cost to Refinance Your Mortgage?
With every major loan, whether it’s the initial mortgage or a refinance, there’s going to be a long list of fees by the lender. Of course, these will vary based on location, your credit score, and the lender’s internal policies.
Generally speaking, total closing costs on a refinance can range anywhere from 2 to 6% of the loan amount. That means for every $100,000 you refinance, expect to pay anywhere between $2,000 and $6,000.
What makes up the bulk of these closing costs? They typically include the following:
- Application fee – $75 to $300
- Loan origination fee – Up to 1.5% of the loan’s principal
- Appraisal fee – $300 to $700, if needed
- Title search and insurance – $700 to $900
- Discount points – Optional. If you want a lower interest rate than what’s being offered, most lenders will ask around 1% of the loan amount to decrease it by 0.25%
- Other miscellaneous fees
How Much Can You Save by Refinancing Your Mortgage?
In most cases, a lower interest rate will result in a lower monthly payment. However, the exact amount will depend on several other factors such as the amount being refinanced, loan duration, whether or not any cash was taken out, etc. Closing costs can also make a difference.
To illustrate the benefit, let’s consider two 30-year fixed rate mortgages where the only variable that changes is the APR. Assuming $240,000 was borrowed (a $300,000 home minus a 20% down payment),
- An 8% APR would result in a monthly payment of $1,761
- A 6% APR would result in a monthly payment of $1,439
- That’s a savings of $322 per month!
Keep in mind that the monthly payment is just one way to look the potential savings. When you think about the total life of the loan, there can also be a substantial amount of money saved. Using the figures above, the total amount saved would be $115,920 over the next 30 years.
How Much of a Difference in Interest Rates Makes Refinancing Your Mortgage Advantageous?
A good rule of thumb is to consider refinancing if the current interest rate is a minimum of 1% lower than the APR of your mortgage.
Again, that will greatly depend on the factors we’ve already highlighted above. Before moving forward, it’s a good idea to calculate the potential savings. This can be done with a simple, free online Mortgage Refinance Calculator.
Should I Refinance Now or Wait?
The recent interest rate drop from the Fed may have been enough to make it worth your time to refinance your mortgage. However, does that mean you should take action right away? According to the expectations published by the Federal Reserve, there may still be some further savings to be had.
Periodically, the Fed publishes a widely quoted graphic known as the “dot plot”. Essentially, this is a chart over the next few years which depicts where they expect to see interest rates fall. As of the September meeting, Fed members predict the benchmark rate will be:
- 4.4% by the end of 2024
- 3.4% by the end of 2025
- 2.9% by the end of 2026
Of course, these are only estimates, and in no way does this mean that mortgage rates will also fall by these same increments. However, the Fed dot plot does seem to paint the picture of a downward trend in interest rates over the next few years.
Again, the only way to know for sure if a refinance is to your benefit is to crunch the numbers. Depending on your current loan terms, it could even make sense to refinance now followed by another one in a few years if rates continue to fall significantly. It will all depend on your financial situation and needs.
The Bottom Line
Refinancing your mortgage can be a very helpful way to reduce your monthly payments and make room in budget. However, it’s essential to weigh the costs and benefits carefully. The best approach is to familiarize yourself with how these loans work and then use an online calculator to crunch the potential savings. Beyond that, keep your ears perked for further Fed meetings and rate drops that might make your situation even more adventegous.
Featured image credit: Stockvault.net
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