Maybe you’ve considered refinancing your mortgage, but you’ve only dipped your toe in the exploratory waters. Is now the right time? Will rates stay low? Could they go lower?
It can be hard to know when to take the plunge.
Whether you purchased a home recently or bought a home years ago, you probably noticed that average mortgage rates continued to hover near historic lows in early 2021.
But as with any financial rate or data point, it is hard—if not impossible—to time the market or predict the future.
Homeowners often look to refinance when it could benefit them in some way, like with a lower monthly payment. Refinancing is the process of paying off a mortgage loan with new financing, ideally at a lower rate or with some other, more favorable, set of terms.
Here are seven signs that locking in a lower mortgage rate now could be the right move.
1. You Can Break Even Fairly Quickly
Refinancing a mortgage costs money—generally 2% to 5% of the principal amount. So if you are refinancing to save money, you’ll likely want to run numbers to be sure the math checks out.
To calculate the break-even point on a mortgage refinance—when savings exceed costs—do this:
1. Determine your monthly savings by subtracting your projected new monthly mortgage payment from your current monthly payment.
2. Find your tax rate (e.g., 22%) and subtract it from 1 for your after-tax rate.
3. Multiply monthly savings by the after-tax rate. This is your after-tax savings.
4. Take the total fees and closing costs of the new mortgage loan and divide that number by your monthly after-tax savings. This yields the number of months it will take to recover the costs of refinancing—or the break-even point.
For example, if you’re refinancing a $300,000, 30-year mortgage that has a fixed 6% rate to a new 4% rate, refinancing will reduce your original monthly payment from $1,799 to $1,432—a monthly savings of $367. Assuming a tax rate of 22%, the after-tax rate would be 0.78, which results in an after-tax savings of $286.26. If you have $12,000 in refinancing costs, it will take nearly 42 months to recoup the costs of refinancing ($12,000 / $286.26 = 41.9).
The length of time you intend to own the home can affect whether refinancing is worth the expense. You’ll want to run the calculations to make sure that you can break even on a timeline that works for you.
The rate and fees usually work in tandem. The lower the rate, the higher the cost. (“Buying down the rate” means paying an extra fee in the form of discount points. One point costs 1% of the mortgage amount.)
If you’re shopping, each mortgage lender you apply with is required to give you a loan estimate within three days of your application so you can compare terms and annual percentage rates. The APR, which includes the interest rate, points, and lender fees, reflects the true cost of borrowing.
2. You Can Reduce the Rate by at Least 0.5%
You may have heard conflicting ideas about when you should consider refinancing. The reason is that there is no one-size-fits-all answer; individual loan scenarios and goals differ.
One commonly espoused rule of thumb is that the home refinance rate should be a minimum of two percentage points lower than an existing mortgage’s rate. What may work for each individual depends on things like loan amount, interest rate, fees, and more.
However, the combination of larger mortgages and lenders offering lower closing cost options has changed that. For a large mortgage, even a change of 0.5% could result in significant savings, especially if the homeowner can avoid or minimize lender fees.
Maybe rates are low enough that you choose to take a higher rate with a no closing cost refi.
3. You Can Afford to Refinance to a 15-Year Mortgage
When you refinance a loan, you are getting an entirely new loan with new terms. Depending on your eligibility, it is possible to adjust aspects of your loan beyond the interest rate, such as the loan’s term or the type of loan (fixed vs. adjustable).
If you’re looking to save major money over the duration of your mortgage loan, you may want to consider a shorter term, such as 15 years. Shortening the term of your mortgage from 30 years to 15 years will likely cost you more monthly, but it could save thousands in interest over the life of the loan.
For example, a 30-year $1 million loan at a 7.5% interest rate would carry a monthly payment of approximately $6,992 and a total cost of around $1,517,172 over the life of the loan.
Refinancing to a 15-year mortgage with a 5.5% rate would result in a higher monthly payment, about $8,171, but the shorter maturity would result in total loan interest of around $470,750—an interest savings over the life of the loan of about $1,046,422 vs. the 30-year term.
One more perk: Lenders often charge a lower interest rate for a 15-year mortgage than for a 30-year home loan.
4. You’re Interested in Securing a Fixed Rate
Borrowers may take out an adjustable-rate mortgage because they may get a lower rate (at least initially) than on a fixed-rate mortgage for the same property. But just as the name states, the rate will adjust with market fluctuations.
Typically, ARMs for second mortgages such as home equity lines of credit are “pegged” to the prime rate, which generally moves in lockstep with the federal funds rate. First mortgage ARM rates are tied more closely to mortgage-backed securities or the 10-year Treasury note.
Even though ARM loans come with yearly and lifetime interest rate caps, if you believe that interest rates will move higher in the future and you plan to keep your loan for a while, you may want to consider a more stable fixed rate.
Refinancing to a fixed mortgage can protect your loan against rate increases in the future and provide the security of knowing how much you’ll be paying on your mortgage each month—no matter what the markets do.
5. You’re Considering an ARM
You may also be considering a move in the other direction—switching from a fixed-rate mortgage to an adjustable-rate mortgage. This could potentially make sense for someone with a 30-year fixed loan but who plans to leave their home much sooner.
For example, you could get a 7/1 ARM with a potential lower interest rate for the first seven years, and then the rate may change once a year, when up for review, as the market changes. If you plan to move on before higher rate changes, you could potentially save money.
It’s best to know exactly when the rate and payment will adjust, and how high. And it’s important to understand the loan’s margin, index, yearly and lifetime rate caps, and payments.
6. You’re Considering a Strategic Cash-Out Refi
The lender will provide you with cash and in exchange will increase your loan amount, which will likely result in a higher monthly payment.
If you go this route, realize that you’re taking on more debt and using the equity you have built up in your home. Market value changes may result in a loss of home value and equity. Also, a mortgage loan is secured by your home, which means that the lender can seize the property if you are unable to make mortgage payments.
A cash-out refi may make sense if you use it as a tool to pay less interest on your overall debt load. Using the cash from the refinance to pay off debts carrying higher rates, like credit cards, could be a good move.
Depending on loan terms and other factors, a lower rate may allow for overall faster repayment of your other debts.
7. Your Financial Situation Has Improved
When putting together an offer for a mortgage, a lender will often take multiple aspects into consideration. One of those is prevailing interest rates. Another is your financial situation, like your credit history, credit score, income, and debt-to-income ratio.
The better your personal financial situation in the eyes of the lender, the more creditworthy you are—and the better the terms your loan offer could be.
Therefore, it may be possible to refinance your mortgage loan into better terms if your financial situation has improved since you took out the original loan, especially when paired with relatively low market rates.
Is it time to refinance? Is the prospect of a lower interest rate or different loan term exciting? Locking in a lower rate now could help you achieve your long-term goals by freeing up cash for other stuff, like retirement or a big vacation.
Sometimes folks spend so much time sweating the small purchases (like the dang lattes) when really, it’s the big money moves—like refinancing—that can make the biggest difference over time.
If you’re interested in refinancing, you may want to look for a lender that’s offering competitive rates and great customer service.
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