Taking a brief look at the history of mortgage rates, they are on a steady decline since the 1980’s, when we were seeing interest rates of up to 17.6%! However, in a more recent comparison rates have continued to drop since 2008, when they were sitting at around 6-7% for a 30 year fixed rate mortgage.
Now, interest rates are at a record-low, currently sitting around 3.5% for a conventional fixed rate 30-year mortgage. However, that figure can easily change from one day to the next, and as the economy gets stronger these rates will likely start to climb up as well. So that obviously means its time to lock it in and refinance..
Well, not exactly.
A lower interest rate is a big motivator for many to refinance their homes but the more important question is how much lower the rate needs to be, to breakeven on closing costs. That is to say that the length of time it will take to be at the point of zero profit or zero loss. Depending on the size of the mortgage, it may not be justifiable to do a refinance, as closing costs can add up.
Closing costs can range anywhere from 2%-5% of the total loan amount, with the average closing cost sitting at $3,700 according to a survey done by Zillow.
If someone has a home with a $2M mortgage, the 1% rate reduction will make a noticeable difference, and the costs of closing will breakeven in approximately 10 months or so. Whereas someone with a $150,000 mortgage will likely get overwhelmed with closing costs and may take much longer to recoup from the refinance.
Another important factor with refinancing is the length of time you plan to stay in the home. The longer you stay in the home, the more time you will have to break even on closing costs, and reap the benefit of a lower interest rate. Only if you will be staying in the home past the breakeven point, will it make sense to refinance. If you can see yourself there for another 5 years or more, it will definitely be worth it.
If you are planning to sell your property within the next year or so, it won’t give you much time recoup your costs. This is especially the case if the rate reduction is minimal, as it will take longer to make up the costs of refinancing.
Unsure of where you fall in the spectrum? Try this refinance breakeven calculator to see if a refinance makes sense for you.
When evaluating how much you will save each month, be mindful of the term of the new loan. Extending the term from 20 to 30 years will inevitably reduce the monthly payments, even with the same interest rate.
However, you will end up paying more interest because of the extra decade of payments, then you would if you didn’t refinance. Be careful not to fall into this trap unless you are specifically looking to lower your payment at any cost, due to financial hardship or lack of job security.
For some it is worth it to pay more in interest over a ten-year span of time, if that means they can stay in their home for longer.
Lower interest payments can also affect your taxes; in that there will be smaller tax deductions reflective of your lower interest payments. Just food for thought.
Another reason homeowners refinance is because they have managed to improve their credit score, qualifying them for a lower rate. Rates can vary by as much as 1.5% based on credit score, which can equate to hundreds of dollars of monthly savings.
On that note, the best mortgage rates are available to applicants with FICO scores of 760 and up- so that alone should be motivation enough to work improving your credit.
Finally, another reason someone may refinance their home is to take advantage of the equity they have built up. Think about it- after 15 or 20 years of payments there is likely to be a lot of equity built up in the home. Why let that money sit there, instead of making it work for you?
If there is one thing universal truth in finance, it’s that inflation is always affecting the value of our money. A thousand dollars today, will not be the same thousand dollars in five or ten years. Knowing that, we should be diligent to grow our money at least at the same rate as inflation.
So many homeowners are now looking to low risk investments to increase retirement funds, or savings accounts. At the end of the day the property will keep its value, and in most cases keep appreciating year by year.
A refinance can offer the homeowner the ability to keep their home, keep building the equity in their home, and pull out a decent investment to grow their savings.
The trick here is to refinance at a low interest rate, and put your investment into something with a high enough yield, so that a percentage may be put into a savings account after monthly fees. It’s a bonus if you can get a home equity line of credit, or an interest only mortgage. That way you only pay interest on the portion that you are taking out, or avoiding extra principle payments when possible.
Of course, it goes without saying that any investment should be thoroughly vetted, and for those new to investments, it’s worth discussing this option with a trusted financial advisor.