Should You Refinance When Mortgage Rates Drop?
According to data from the Mortgage Bankers Association, mortgage applications went up recently as the 30-year rate dropped to the lowest level since March. Based on the data, the 30-year fixed rate fell to 6.87%, and mortgage application activity went up 4%, with the assistance of a 15% jump in refinances, which reached the highest level since August 2022. Since many homeowners are thinking about refinancing their mortgages as interest rates come down, let’s review whether the process makes sense.
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Look Into How Much You Can Save on Mortgage Payments
“One of the primary reasons to refinance is to lower your monthly mortgage payments,” said Taylor Kovar, CFP, founder of 11 Financial. “When interest rates decrease, refinancing to a lower rate can reduce your monthly payment amount, freeing up cash flow that can be redirected toward savings, investments or other financial goals.”
Before you decide to refinance your mortgage when interest rates drop, you’ll want to run some calculations to see how much money you could save from going through the entire process. It’s important to mention that you’ll have to spend a hefty amount on closing costs to refinance your mortgage, so you’ll want to ensure the savings are worth it.
Let’s look at an example as reported by CBS. If you spend $8,000 on closing costs to save $200 on your monthly mortgage payment, it would take 40 months to break even. You’ll want to gather all relevant numbers since some lenders may share only the monthly savings with you.
Most experts will agree it’s worth refinancing if you can drop your current mortgage rate by 1% or more. However, you’ll want to run the calculations to see how much you would save on your monthly mortgage payments compared with the total closing costs.
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Consider How Long You Plan On Staying in the Home
“If you plan to sell the home within the next several years, it may not make sense to refinance, given some of the costs that are involved in the transaction,” said Chris Urban, CFP, RICP, founder of Discovery Wealth Planning. “If you plan to remain there indefinitely, then you certainly would want to consider the financial benefit(s) of refinancing.”
If you plan on living in your current residence for the long run, you’ll benefit from refinancing by saving on your housing expenses. However, going through the paperwork may not make sense if you’re likely moving in the next few years.
“Refinancing to a lower interest rate can save you money over the life of the loan by reducing the total interest paid,” Kovar said. “This is a great advantage if you plan to stay in your home for a long time, the cumulative savings can be substantial.”
Review Your Financial Situation
“Lenders consider your credit score, income stability and debt-to-income ratio when approving a refinance,” Kovar said. “A strong credit score and stable financial situation may qualify you for the best interest rates and terms.”
If your financial situation has improved since you purchased your home, you could get better terms on your mortgage if you refinance. If you’ve paid off debt, increased your income or improved your credit score, you could benefit from the savings of refinancing. You’ll want to ensure that you have the proper paperwork and that your financials have improved before you proceed.
Look Into the Details of Refinancing Your Mortgage
“Financially, you want to consider the specifics of your current mortgage, notably the interest rate, type of mortgage and how that would compare to what is offered under a potential refinancing,” Urban said.
Refinancing your mortgage doesn’t have to be just about saving money on your monthly payments, as you can use it as an opportunity to change the terms. If you purchased your home during the pandemic months, you may have accepted terms that weren’t the most favorable.
“Another strategy is to refinance to a shorter loan term (e.g., from a 30-year to a 15-year mortgage) when rates are lower,” Kovar explained. “While this may increase your monthly payments, it can save you tens of thousands of dollars in interest over the life of the loan and help you build equity faster.”
If you currently have an adjustable-rate mortgage, you could refinance to a fixed-rate mortgage to provide stability and protect yourself against future rate hikes.
Don’t Ignore the Role of Your Home in Your Financial Plan
Urban suggested that you consider the role that your home and the equity in the home play in your personal financial plan. Since your home will likely be your largest asset, you want to think about the impact of refinancing on your future financial plans.
“Consider your long-term financial goals and how refinancing fits into your overall financial strategy. If you plan to move or pay off your mortgage in the near future, the savings from refinancing may not justify the upfront costs,” Kovar said.
Run the Numbers for Refinancing Your Mortgage
Based on data from The Wall Street Journal, the amount you could save from refinancing would depend on when you purchased your home. For example, someone with a $500,000 mortgage balance at a rate of 8% could save $500 per month if they refinanced at 6.5%. However, it’s crucial that you run the numbers to determine your breakeven point based on the monthly savings and the cost of refinancing.
“It’s essential to calculate the costs associated with refinancing, such as closing costs, appraisal fees and possible prepayment penalties. These costs can typically range from 2% to 5% of the loan amount. Compare these costs with the potential savings from refinancing to determine your breakeven point — the time it will take to recoup the costs through lower monthly payments or reduced interest,” Kovar said.
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This article originally appeared on GOBankingRates.com: I’m a Financial Advisor: Should You Refinance When Mortgage Rates Drop?
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