Mortgage Rates Are Down. Should You Refinance?

For today’s homebuyer, mortgages are cheaper than ever. The average rate on a 30-year fixed mortgage fell to 3.29% in early March, the lowest level recorded in almost 50 years. And 15-year mortgage rates came in even lower, averaging a mere 2.79%.1

These exceptionally low rates are tempting many homeowners to refinance their existing mortgages. In fact, refinance applications jumped almost 80% from a year earlier, their highest level in over 10 years.2 But there are a number of factors you’ll want to take into consideration before deciding if refinancing is worthwhile for you.

Rate Differential

The old and arbitrary rule of thumb said that a refi only makes sense if you can lower your interest rate by at least two percentage points — for example, from 6% to 4%. But what really matters is how long it will take you to break even. In other words, make sure you understand — and are comfortable with — the amount of time it will take for your overall savings to compensate for the cost of the refinancing.

Consider this: If you had a 30-year $100,000 mortgage with a 5.5% interest rate, your monthly payment would be $568. If you refinanced at 3.5%, your new monthly payment would be $449, a savings of $119 per month. Assuming that your new closing costs amounted to $2,000, it would take about 17 months to break even ($2,000/$119 = 16.8). If you planned to stay in your home for at least 17 more months, then a refi might be appropriate. 

For most people, however, the rate differential — and monthly savings — are likely to be less dramatic:

Difference Between Old and New Rate Monthly Savings
(assuming 5.5% initial rate)
Months to Break Even, Assuming $2,000 in Closing Costs
0.50% $31 65
0.75% $46 43
1.00% $61 33
1.25% $76 26
1.50% $91 22
1.75% $105 19

Source: DST Retirement Solutions, LLC, an SS&C company. Based on a 30-year, fixed-rate, $100,000 mortgage, including principal and interest.

How Long You Expect to Own the Property

How long you plan to live in your home is a key variable that should influence whether you refinance your mortgage. It’s only worthwhile if you expect to remain in your home long enough to recoup the cost of refinancing.

Closing Costs 

When you refinance, you’re likely to incur a number of different closing costs. You may pay a mortgage broker fee (assuming you do not go directly to a bank or other lender), a title insurance premium, a commitment fee, points, attorney or settlement fees, an appraisal fee, and other costs that add up quickly. So you’ll need to determine whether the savings from a lower rate justify the closing costs.

Here’s a summary of possible closing costs you might encounter:3

  • Appraisal fee ($300-$400)
  • Home inspection ($300-$500)
  • Application fee (varies)
  • Attorney’s fee (hourly)
  • Origination fee (about 0.5% of loan amount)
  • Discount points (1 point costs 1% of the loan amount)
  • Mortgage broker fee (0.50% to 2.75%)
  • Mortgage insurance application fee (varies)
  • Upfront mortgage insurance (0.55% to 2.25%)
  • FHA, VA and USDA fees (1% to 3.3%)
  • Title search fee (about $200)
  • Lender’s title insurance (varies)
  • Owner’s title insurance (0.5% to 1% of purchase price)

Stick With What You Know?

Finally, keep in mind that your current lender may make it easier and cheaper to refinance than another lender would. That’s because your current lender is likely to have all of your important financial information on hand already, which may reduce the time and resources necessary to process your application. But don’t let that be your only consideration. To make a well-informed, confident decision you’ll need to shop around, crunch the numbers, and ask plenty of questions.

Notes
1Source: Yahoo Finance, U.S Mortgage Rates Fall to Record Lows. The Year of Record Breaking May Well Continue, March 7, 2020.

2Source: CNBC, Mortgage refinance applications spike 79% as homeowners rush to take advantage of lower rates, March 11, 2020.

3Source: Nerdwallet.com