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Mortgage rates dropped slightly this week—and have only touched 3% once in the past nine weeks.
While today’s mortgage interest rates are higher than recent all-time lows, they are still exceptionally low. “It’s a good time to be an American consumer, perhaps the best in recent memory,” says Joe Brusuelas, chief economist at RSM, an audit, tax, and consulting firm. “One should not get lost in a haze of ‘I didn’t do this last year.’”
So if you’ve been waiting on the sidelines, unsure of whether or not you should take advantage of these mortgage or refinance rates, you still have an opportunity to lock in a low rate.
A low rate doesn’t always guarantee that your mortgage is a good deal for you. Home prices have risen to the stratosphere and may offset the potential savings buyers could get with a low-interest rate. “We are so interest-rate sensitive,” says Elizabeth Rose, certified mortgage planning specialist with AmCap Home Loans. “[Borrowers] hear somebody at the office got a 2.875% rate, and they just want that rate, but they don’t know why.”
However, the same low rates and rising prices have given people who are already homeowners an extended opportunity to lock in savings by refinancing their current home loan.
The decision to refinance should be about more than just getting a better interest rate. So before you decide whether or not to refinance, here are some things to consider.
Two Questions to Ask Yourself Before You Refinance
There are good rules of thumb to follow when it comes to refinancing.
“I’ve heard throughout my career that unless you can lower your rate by 1% or by 2%, then it doesn’t make sense to refinance,” Rose says. But there are exceptions to every rule, and the decision is ultimately a personal one, she adds. “Maybe to one person, a 1% rate drop doesn’t make sense, but to another person, it frees up enough cash to pay off credit card debt.”
Today’s low interest rates may grab all the attention, but sometimes personal factors are more important to consider. That’s why it’s important to understand why you want to refinance. Here are two big questions to ask yourself.
1. What are your financial goals?
Refinancing a home loan is just one financial tool that can help you reach your goals. Lowering your interest rate, or shortening your loan’s term, can save you thousands of dollars in interest or cut years off of your mortgage. The end goal here is minimizing debt and lowering your debt horizon. If you can afford the higher monthly payments of a shorter-term loan, “that’s a real strong wealth-building opportunity,” Brusuelas says.
You may also want to turn your home’s equity into cash if having the extra money allows you to consolidate other high-interest debt or take advantage of an investment opportunity. Compared to other types of debt, a cash-out refinance could lower the overall interest you’re paying. If you have $20,000 in private student loans at 6% and $5,000 on a credit card at 15%, you may be able to cash out $25,000 of your home’s equity at 3.5% and pay off your other debts.
2. How long will you be in your current home?
Refinancing isn’t free. You’ll usually pay anywhere from 3% to 6% in closing costs. These fees can be paid out of pocket or rolled into your loan balance with a no-closing-cost refinance. Regardless of how you pay them, they should factor into your decision.
In most situations, refinancing makes sense if you’re planning on staying in your home long enough for the savings to outweigh the cost. For example, if you calculate $250 in monthly savings, and your closing costs are $10,000, you would break even in 40 months or just over four years. To calculate your break-even point, divide the upfront cost ($10,000) by your monthly savings ($250). In this case, the $250 monthly savings pays for the closing costs during months 0-40. If you move before month 41, you are at a loss and didn’t save. But month 41 is when the savings begin.