The moment the Federal Reserve announced an upcoming drop in interest rates, millions of Americans likely wondered whether the drop would be enough to justify refinancing their mortgage. As mortgage rates drop, now is an excellent time to decide when refinancing your mortgage makes the most sense. That way, you’ll be ready when and if the rate you’re waiting for arrives.
The following are good indicators that it’s time to consider a mortgage refinance.
The new rate is 1% lower than your current rate
The general rule of thumb is to consider refinancing your mortgage if you can score a rate at least 1% lower than your current rate. While this is good general advice, it may — or may not — apply to your situation. For example, if you’re having trouble making your monthly mortgage payment and a 1% lower rate won’t make much difference, it may not be worth the costs associated with refinancing.
The average cost of refinancing runs between 2% and 5% of your loan amount. For example, if you’re refinancing a $200,000 mortgage, you can expect to pay between $4,000 and $10,000 to refinance. Like any other loan, it pays to shop around for the lowest rate and closing costs.
You can pay the closing costs upfront or roll them into the loan. Rolling it into the mortgage may make sense in the short term, especially if you’re short on cash. However, you have to decide if you want to spend 15 to 30 years paying off closing costs with interest.
Still, there are those for whom refinancing is the wisest option. For example:
- Cameron borrowed $300,000 when they purchased their home but currently owes $225,000.
- Cameron’s current interest rate is 6.5%, and their monthly principal and interest payment is $1,896.
- After a few rate drops, Cameron finds a bank offering an APR of 5.25%.
- Cameron pays closing costs upfront rather than rolling them into the loan.
- Cameron’s monthly principal and interest payment on a new 30-year mortgage drops to $1,242, a savings of $654.
You’ve decided to pay your mortgage off at a faster clip
Imagine that Cameron decides they want to pay their mortgage off faster, so they refinance to a 15-year fixed-rate mortgage instead of a 30-year. Their monthly mortgage payment is $1,809, nearly the same as before they refinanced. However, they’re on course to pay the loan off much more quickly and save thousands of dollars in interest payments.
You want to make a switch from an ARM to a fixed-rate mortgage
As the name suggests, an adjustable-rate mortgage (ARM) has an interest rate that adjusts over time. Also called variable-rate mortgages, ARMs typically start with a lower rate than fixed-rate mortgages, which makes them attractive to those who want to keep their monthly payments low. However, as the market changes, so does their interest rate, and budgeting may become more complex.
Drops in mortgage rates present an excellent opportunity for those with an ARM to switch to a fixed rate they can depend on throughout the life of the mortgage.
You have a balloon payment coming up
There are all kinds of mortgages, including owner financing. When someone sells a home with owner financing, the seller offers to be the lender — at least for a time. All monthly payments are made to the seller, just as they would be to a traditional mortgage company. One thing that many owner-finance contracts include that conventional mortgage lenders do not is a balloon payment.
For example, the buyer may make monthly payments to the seller for five years. At the end of five years, the buyer is expected to refinance the mortgage with a traditional lender and pay the seller the balance due on the property.
Having a balloon payment over your head can be pretty unsettling, making refinancing especially attractive as rates drop.
You’re looking to eliminate mortgage insurance on an FHA loan
No matter how much you put down on a home, if you take out an FHA mortgage, you must pay mortgage insurance for the entire life of the loan. As long as you have at least 20% equity, refinancing the property with a fixed-rate conventional mortgage is an easy way of ridding yourself of mortgage insurance premiums.
Everyone’s “sweet spot” is a little different. While one borrower may wait for rates to drop below 6%, another doesn’t benefit until they’re under 5%. The goal is to determine when refinancing benefits you most and then jump on the opportunity when it arises. In the meantime, you may consider saving enough to pay closing costs upfront to keep your monthly payments as low as possible.
