If there is one word on the mind of every homeowner and financial planner right now, it’s this one: “Refinance”.
And for good reason. Mortgage interest rates are near historic lows: The average for a 30-year fixed rate loan was 3.36% for the week ended March 12, according to Freddie Mac. The average rate for a 15-year loan was 2.77% and for a five-year adjustable rate mortgage it was 3.01%
If that rate is much lower than what you’re paying right now, you can simply slide into a new loan and save on your monthly nut. A slam dunk, right?
Well, not so fast. While refinancing your home loan is a terrific idea for many, it may not be right for you – and that all depends on your personal circumstances. As the old adage goes: Just because you can, doesn’t mean you should.
“There are a few things you need to think about: Number one, can you lower your interest rate?” says Ilyce Glink, founder of financial wellness firm Best Money Moves. “Number two, can you shorten your loan term? Number three, can you lower your monthly payments? And number four, can you keep costs low on getting that refinance?
“If you can get all of those, that’s a total home run. And if you can get two or three, that’s where your own personal finances come in, and you have to think about what your best money move is.”
If refinancing is a fit for you, the savings could make a real difference for your bottom line: About 9.4 million borrowers in America could save an average of $272 a month if they refinanced at a lower rate, according to analytics firm Black Knight. “Our clients would be crazy not to call their mortgage brokers and take advantage of these rates,” says Tom Balcom, a financial planner in Lauderdale-by-the-Sea, Fla.
Should You Refinance Your Mortgage
So when should you sign on the dotted line of a refinanced home loan? Here are some factors to consider:
-Rate differential. What’s the spread in interest rates between what you’re paying right now, and what you could get in a new loan? The general rule of thumb historically has been that a 1% difference or more makes it worth your while to refinance – although these days it’s more like 0.5% or higher.
As an example, if you buy a $250,000 home and put down 20%, and are paying 5% interest on the balance for 30 years, that’s a monthly payment of $1,632. But with an interest rate of 3.5%, you’re saving almost $200 every single month.
Of course, we are in a prolonged era of rock-bottom rates, and you may be one of the millions of homeowners who have already refinanced. In that case, if the rate differential is only a quarter-point, it may not be worth the hassle, paperwork and extra fees to go through that process all over again. Typical closing costs, for instance, might be roughly $3,000-$5,000.
-Time in the home. Now you need to think about how long you’re going to stay in your current home. If you see yourself being there for a very long time, then refinancing to a lower rate may be a no-brainer.
But people move all the time – maybe a growing family needs more space, maybe your job is taking you to another city, maybe a retiring couple plans to downsize. If you foresee selling in the near-term, then it’s probably not worth it to refinance – because whatever you’re saving in monthly payments, won’t recoup the costs associated with taking out a new loan.
“If it costs you $2,000 to save $200 a month, then after you’ve lived in the home a year, you’ve saved enough to offset the fees which probably means the refinance makes sense,” says Danielle Hale, chief economist for Realtor.com. “If you’re not sure that you’ll be in the home for long, then you may want to wait.”
-Term of the loan. Let’s say you’re already six or seven years deep into a 30-year loan. Refinancing to a new 30-year would certainly lower your monthly payments, not just because of a potentially lower interest rate, but because you’re lengthening the term.
But is that really what you want? If your ultimate goal is to live in a paid-off house, then you’re delaying that dream.
Another possibility, and a wise one if you can afford it: Taking advantage of tiny rates to change the term of the loan, and switch from a 30-year to a 15-year. Because of the compressed timeframe you might even pay more on a monthly basis, even if the new rate is lower – but if you have the financial means to do so, it means that house will be yours far ahead of schedule. For near-retirees wondering how they will pay for their golden years, that’s a massive win.
“If you’re in the later years of paying off your mortgage, it can make sense to go to a shorter-term loan when you refinance,” says Hale. “First, this will keep you mostly on target with your original payout date. Second, you could see even bigger interest-rate savings, since 15-year mortgages tend to have lower rates.”
-Compare offers. National loan averages are interesting, but they don’t mean much when they come to your particular case. Your own loan offers are going to come down to factors like personal credit history, the amount of equity in the home, and so on.
Word to the wise: Don’t just get one lender offer and call it a day. “I would love for people to talk to three or four or five lenders,” advises Glink. “Big national lenders, regional banks, credit unions, local mortgage brokers. These days the Internet makes it all so easy.”
-Don’t overthink where rates are headed. Of course once you lock in a new rate and refinance, rates could continue to go even lower, and make you wonder whether you could have saved even more. With coronavirus spreading and the Federal Reserve seemingly quick to take action and slash its own benchmarks, that is certainly possible.
It’s a dangerous game to play, though. Firstly, mortgage rates don’t always march in lockstep with the Fed’s moves. They should drift downwards with recent cut, but there are no guarantees. Secondly, virtually no one is going to time their new loan absolutely perfectly -- and individuals are notoriously bad at timing markets, anyways.
“My prediction is that pretty soon banks are going to stop lending money,” says Glink. “People think rates are going to go lower and lower, but they literally can’t. So look at your situation, and if it makes sense for you to refinance, don’t even wait – just go ahead and do it.”