This week’s decrease bucks the trend of slowly rising mortgage interest rates, which we saw leading up to the Federal Reserve’s announcement that it would begin unwinding its pandemic-era policies that have helped keep rates low. However, don’t expect to see a sustained reduction in rates in the coming months, as many experts expect mortgage rates to rise towards the end of 2021.
Throughout the last 18 months, borrowers have had access to historically low mortgage rates. If you haven’t taken advantage of these rates, the window to refinance or lock in an exceptional interest rate is still open. But before you refinance, you’ll want to take a step back and make sure that it is the right next move for your circumstances and goals.
Here are three questions to ask yourself before committing to a mortgage refinance.
3 Questions to Ask Yourself Before Refinancing
Overall, now is a good time to refinance when you consider how low interest rates are. But there is more that goes into refinancing than just the interest rate.
1. What Are Your Goals?
Refinancing is just one tool that can be used to help you reach your financial goals. It’s important to have a clear understanding of what you want to accomplish before you start comparing mortgage lenders or analyzing various types of loans.
Depending on your financial goal, choosing the right refinance loan type that best aligns with your goal is key. As an example, a rate and term refinance can reduce your monthly housing costs. You can then use the freed-up funds to pay down credit card debt. But a cash-out refinance could be used to finance a home upgrade. Knowing what is most important to you and your goals can help you hone in on the right decision.
2. Is It Worth the Cost?
Refinancing isn’t free, so the decision isn’t always as simple as looking at your current interest rate and seeing if you can qualify for a better rate. There are upfront closing costs that need to be accounted for. They range from 3% to 6% of the loan balance. To help homeowners decide if a refinance is a good move or not, a good rule of thumb is: if you can lower your interest rate by 1% or more, then you could see significant benefits.
Here’s an example of a homeowner who purchased a $400,000 home with a 5% down payment four years ago ($350,919 remaining balance). Assuming a 4% interest rate on a 30-year loan, here’s what the savings would look like by cutting the rate by 1% on a new 30-year refinance loan.
|Loan Amount||Interest Rate||Monthly Principal & Interest Payment||Interest Remaining|
If there are $12,000 in closing costs, it will take roughly three years for the $335in monthly savings to offset the upfront fees. How long you expect to stay in the home before selling, or possibly refinancing again, should factor into your decision.
The interest paid over the remaining loan term would drop by over $30,000 with a refinance, but this homeowner would be adding four years back onto their mortgage by taking out a new 30-year mortgage. You could also reduce your repayment term with a shorter 20-year loan or a 15-year loan, but this would increase your monthly payment. So it’s a tradeoff.
3. Is Refinancing the Best Way to Achieve Your Goals?
Refinancing may not be the best strategy for accomplishing your goals, and it also isn’t an option for every homeowner.
Instead of taking out a cash-out refinance loan, you could open a home equity line of credit (HELOC). In this scenario, you’ll keep your existing mortgage and open a line of credit that is secured by your home. As with any loan option, there are pros and cons to consider. For example, with a HELOC, you only pay interest on what you spend. With a cash-out refinance, you’re paying interest on the full amount from day one.
If you want to reduce the total interest you’re paying, you could increase your monthly payments and pay off your mortgage early. This method reduces the overall interest paid and gives you more flexibility if you experience an unexpected loss of income without involving a refinance or closing costs.