For the first time in 50 years, mortgage rates fell below 3%. For the week ending July 16, 2020, the 30 year fixed mortgage rate averaged 2.98% and the 15 year fixed mortgage rate averaged just 2.48%. These ridiculously low rates should have you wondering, is it time to refinance your mortgage? For many, the answer will be yes. Refinancing at today’s new rates and saving money with a lower interest rate seems obvious. Other benefits may not be as apparent. Switching to a shorter-term mortgage and paying-off your house faster may be beneficial. Even a cash-out refinance to draw some extra cash off your equity could be attractive in certain situations. Here are a few things to consider when looking at your options.
How much lower is the rate?
Obviously, the bigger the rate drop, the bigger savings a refinance will provide. Mortgage rates have been low for the last few years. In fact, looking at the chart from Freddie Mac below, you can see that the 30 year fixed rate was below 4%, and even below 3.5%, during multiple times over the last 10 years. It’s quite possible that you already have a very low rate. Conversely, there are a few times where the interest rates were around 5%. With the recent drops, I think even a ½ % decrease in interest rate is worth it to spend the time to do the math and review your options. You will either confirm that is it a good idea or figure out that it is not worth the hassle.
What are the costs?
Unfortunately, there is no such thing as a free lunch. When you refinance a mortgage, you likely will face appraisal costs, origination fees, and others as part of closing costs. LendingTree estimates these costs to run between 2% and 6% of your loan. Some lenders run promotions and discount these fees, so it is extremely important to shop around. When you have an estimate of your refinance costs, compare those to the interest savings you will receive by refinancing and figure out how long you will need to stay in the house to realize the extra savings. It’s likely that if you plan to sell your home in the next few years, it will not be worth refinancing your home. If you live in your “forever” home, the long-term savings could significantly outweigh the upfront costs.
What are the terms?
Typically, fixed rate mortgages tend to be either 15-year or 30-year terms. When you refinance, you may either finance into a loan with a quicker pay-off date or one further out. Realize, that if you go from a mortgage with 20 years left on it, and refinance into a 30-year mortgage, some of the monthly savings from a refinance will be due to extending the term of the loan. Also realize that mortgages are very heavily front-weighted with interest costs (i.e. during the early stages of a mortgage you pay more in interest then you do in principle). Be aware of the terms of the new loan and consider how it impacts your pay-off timing. For some, extending the terms of a loan can be a disadvantage. For others it may be beneficial by reducing required monthly cash flow. You can always increase your payments at your discretion and pay it off quicker. Just as extending the term of your loan can be either beneficial or adverse depending on your situation, refinancing to a shorter-term mortgage can provide similar outcomes. Even with reduced interest rates, refinancing to a shorter-term mortgage may increase your monthly payments. If you have enough of a spread between your current rate and the new interest rates your payment may not drastically change and this strategy can be a good way to force a quicker pay-off.
Taking the next steps
I believe that with the rates where they are, you should evaluate if a refinance is right for you. The first step is to start shopping rates. While FreddieMac’s site lists the average rate as 2.98%, when I go look at some of the local bank/credit union rates, they are higher. Shop around, do rate searches online, and find the best deal. Consumersadvocate.org reviews a few, but not all, of the online lenders you should shop here. Once you find the best deal, use calculators such as this one to help figure out your savings and how long it will take to make up the difference in costs. Ideally you should look at more than just how the monthly mortgage payment changes, considering the total interest throughout the life of the loan, and how the pay-off date, changes. Finally, if you look again at the FreddieMac chart, you will see that the rates fluctuate quite a bit. Just like trying to time the stock market, I think it is very difficult to time the bottom of the mortgage market. If it makes sense in your situation to refinance your mortgage, my advice is to go for it instead of trying to time the perfect spot to pull the trigger.
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