As I sit down to write this article, federal interest rates are historically low. And although the federal funds rate and mortgage rates aren’t directly tied together, there’s still a good chance that you may be able to find a lower interest rate than what you’re paying on your current mortgage.
Because rates are lower, many people are wondering whether it’s a good time to refinance their mortgages. Unfortunately, there’s no clear answer that will apply to everyone’s situation.
In some cases, refinancing your mortgage is wise. Yet for other people, it’s not a good move. Read on to learn how to determine if you should refinance your personal home loan.
Pros and Cons of Refinancing a Mortgage
|A lower rate may help you save on interest.||Loan costs might outweigh your savings.|
|Refinancing to a lower rate loan could lower your monthly payment.||If you take out a new 30-year loan, it will take you longer to pay off the debt.|
|You may be able to use the equity in your home to pay down high-interest debt.||Using equity to pay off debt is dangerous if you don’t break overspending habits.|
Is It a Good Idea to Refinance Your Mortgage?
When it comes to interest rates, lower is better. But if you only look at the interest rate when you decide whether or not to refinance your home loan, you’re skipping some important steps.
Before you pick up the phone to call the mortgage lender of your choice, there are several questions you need to ask yourself first.
- Is your credit strong enough to qualify?
- Is a lower interest rate available?
- What are the costs to refinance?
- How long do you plan to stay in your home?
Is Your Credit Strong Enough to Qualify?
Before you start loan shopping, take an honest look at your credit. Your three credit reports and scores play a huge role in whether or not you can qualify for a new mortgage. If you do qualify, your credit will have an impact on the rate you’re offered. (Better credit generally equals lower interest rates.)
You can claim your three free credit reports once every 12 months at AnnualCreditReport.com. There are also several places you can access free credit scores online. Some of my favorite credit score resources include:
- Credit Karma — Free credit scores (VantageScore 3.0) from TransUnion and Equifax
- Experian — Free credit score from Experian (FICO Score 8)
If you discover problems, you may need to work to improve your credit before you apply for a loan. I know from experience that credit challenges can be stressful. But, with the right plan, it is completely possible to turn your situation around.
Is a Lower Interest Rate Available?
Although a lower rate shouldn’t be the only reason you refinance your mortgage, it does matter. Some professionals say that a refinance is worth considering if you can lower your interest rate by at least 1%. Others say you only need a 0.5% savings to make a refinance worthwhile. There are a lot of opinions on the subject, so you have to decide what makes sense for you.
Crunch the numbers to see how much money a lower rate could save you.
What Are the Costs to Refinance?
Taking out a new mortgage comes with a lot of fees, also known as closing costs. You may choose to pay closing costs outright, finance them into your loan, or get a “no fee” loan in exchange for a higher interest rate. But no matter what you choose, you have to pay for those costs.
Refinance costs may include:
- Appraisal Fee
- Home Inspection
- Application Fee
- Attorney’s Fees
- Loan Origination Fee
- Mortgage Insurance Fees
- Title Insurance fees (Owner’s and Lender’s)
- Upfront HOA fees
- And more
On average, you’ll pay 2%–3% of the loan amount when you refinance a mortgage. So, if you’re refinancing a $200,000 home loan, fees ranging between $4,000 to $6,000 are common. (Be careful, some lenders charge higher than average fees.)
Once you know the costs to refinance, you can calculate whether a lower interest rate will save you enough to offset those fees.
How Long Do You Plan to Stay in the Home?
Next, it’s time to consider how long you plan to stay in the home. Whether you plan to move in the near future or stay put is a huge part of determining whether or not to refinance a mortgage.
Let’s say you took out your original home loan two years ago. It’s a 30-year fixed-rate mortgage for $300,000 with an interest rate of 5.5%. You refinance to a new 30-year fixed-rate mortgage with a rate of 4%. But you’ll have to pay $7,500 in closing costs to do so.
Here’s a look at the savings potential:
|Original Mortgage (5.5%)||New Mortgage (4%)||Savings|
|Monthly Payment||$1,703||$1,394||$309 Per Month|
|Total Loan Interest||$313,212
($32,570.30 Already Paid)
In the scenario above, it would take you a little over two years to reach the “break-even” point on your new mortgage. At that point, you will have saved enough on your monthly payments to offset the $7,500 in loan fees you incurred when you refinanced. After that point, the savings would continue to pile up.
However, the same scenario wouldn’t make sense to refinance if you were planning to sell your house in 12 months. In that case, you would have only saved $3,708 ($309 X 12 months). That savings wouldn’t offset the money you paid to refinance.
Figure out the break-even point on your new mortgage to see if refinancing your home loan makes sense. This online calculator may help.
The Bottom Line
Only you can figure out whether it’s a good time to refinance your mortgage. There’s no universal answer, and everyone’s situation is different.
If you run the numbers and decide that you do want to refinance your mortgage, take the time to shop around. Rates and fees can vary between lenders. Do your homework and make sure you find the best deal available for your situation. You’ll be glad you didn’t rush the process in the long run.