If you’re thinking refinance rates are not attractive anymore, think again.
Mortgage rates took a dramatic turn in 2022 when rates spiked close to where they were two years ago. But history shows that mortgage and refinance rates could still be beneficial. It all depends on your current rate. For comparison, there were long periods in the 2010’s where the average 30-year fixed mortgage rate was between 4.5%-5.5% and between 2006 through 2008, rates were above 6%.
What’s important for homeowners to focus on is if they can lower their rate and by how much, not where rates are right now.
In fact, the number of “high-quality refinance candidates” stands at 2 million, according to the latest data provided by mortgage technology and data provider Black Knight. These homeowners all have 30-year mortgages with rates 0.75% or more above average mortgage rates. Refinancing with a 0.75% interest rate reduction can provide significant homeowners savings: An average of $212 a month. Black Knight points out that the number of people able to lower their rate by at least 0.75% is closer to 4 million, if you exclude the eligibility criteria.
If you’re one of the 4 million, there is plenty to consider to make sure a refinance makes sense, from closing costs to how long you plan to be in the house. “Homeowners need to be really careful to make sure that the refinance actually makes sense for them,” says Kyle Seagraves, certified mortgage advisor with the homebuyer education site and YouTube channel Win The House You Love.
So before you sign the bottom line on a mortgage refinance, here is what you need to look at first.
Does a Mortgage Refinance Make Sense For You?
Closings costs are an important consideration to any refinance. Don’t fall into the “I lowered my monthly payment” trap and not account for closing costs, Seagraves says.
Here are the questions you can ask yourself:
1. Will the savings outweigh the cost?
Refinancing isn’t free. “A lot of people don’t realize that you have to pay upfront money to get monthly cost savings,” Seagraves says.
Here’s how to evaluate the cost-benefit of a refinance:
Closing costs: Every time you refinance, you’ll pay closing costs that typically range from 3% to 6% of the loan amount. And just like with your interest rate, these fees vary by lender. “Pay attention to closing costs that the lender controls,” says Matthew Garland, division manager with the Garland Mortgage Group and co-host of the Rants & Gems real estate podcast. The main fees the lender sets are origination fees and discount points found in section A of your Loan Estimate.
Break-even point: Once you know how much less interest you’re paying each month, then you can calculate your break-even point. If you’re saving $200 a month in interest and have $15,000 in closing costs, it will take you 75 months, or just over six years, to break even. Once you know your break-even point, then it’s easier to determine if you plan on keeping your home long enough to justify the cost of a refinance.
Be sure to factor in the closing costs when deciding on a refinance, and remember, even a “no-cost” refinance has a cost.
2. Will the refinance help you achieve your financial goals?
When you’re thinking about refinancing, take a step back to reassess your broader goals for your life and your finances. Whether or not a refinance makes sense for you depends on what you’re trying to accomplish. Here are some common refinance goals, and how to consider whether they make sense for you:
Pay off a mortgage sooner: For homeowners who desperately want to pay off their 30-year mortgage, it can make sense to refinance to a shorter-term loan. With a 15-year refinance, you’ll get a lower interest rate and pay much less in total interest, but you’ll be committing to a larger monthly payment.
Here’s an example:
|Loan Term||Loan Amount||Interest Rate||Monthly Payment||Total Interest Paid|
Staying liquid: A 30-year loan’s lower payments give you much more flexibility if something unexpected happens, such as a job loss. So if you don’t want the extra risk of having larger payments, you could take out a 30-year loan and pay it as if it were a 15-year loan. Then if you have a reduction in your income, you aren’t locked into the higher monthly payments. The main trade-off is that 30-year loans have higher interest rates.
Special projects: Recently, Garland was working with clients considering a standard rate and term refinance and who wanted to invest in rental properties. “It made more sense for them to do a cash-out refinance to pull some equity out,” Garland says.
Cash-out refinances can also work for home improvement projects and paying off other high-interest debt. A cash-out refinance will increase your loan balance, but it can still make sense if you have a sound plan for the money.
The Bottom Line
No matter what your situation is, getting a better mortgage rate is only the beginning when it comes to refinancing. It’s essential to pay attention to the cost of the loan, and to consider if refinancing is the best option for accomplishing your goals. Approach the decision to refinance as an investment, as something you’re paying for, to make sure you’re getting back more than you put into it, Seagraves says.
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