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With Mortgage Rates This Low Should I Refinance My Mortgage?

There’s been a lot of chatter in the news recently given plummeting interest rates and inverted yield curves.  An important topic that hasn’t gotten a lot of press is the recent sharp drop in mortgage rates.  In fact, as recently as late 2018, 30-year mortgage rates were in the 5.0% range but now that same mortgage is hovering in the 3.5% range.

As the chart below shows, mortgage rates (green line) haven’t been this low since late 2012 and for a brief time in mid 2016. Today, millions of U.S. homeowners are eligible to secure mortgage rates much lower than what they currently have (blue bar).   

                                                     Millions of Households Eligible For Mortgage RefinancingSource: Black Knight Financial Technology Solutions

So is now a good time for me to refinance my mortgage?

First off, to see if you would qualify for a refinancing, you will need to dig up the necessary paperwork to present your case. Most banks look at different criteria, but they generally assess the following:

  • You’ve kept and paid on time your original mortgage for at least 12 months.

  • Your credit score. A lower score could result in a higher refinancing interest rate.

  • You have at least 10-20% equity in the property that you want to refinance.

  • Your income is fairly stable over time and that existing debt obligations won’t hinder your refinance mortgage payment.

Refinancing Rule Of Thumb

A good rule of thumb when considering a refinance is if one can lower their mortgage interest by 0.50% or more. Since there are usually closing costs tied to a mortgage refinance, you want to have your mortgage payment savings exceed closing costs. Knowing how long you are going to stay in the house post refinance is an important consideration given closing costs.

In a scenario where your refinance closing costs are $2,500 and your monthly savings are $125 with the refinancing, it would take you 20 months to breakeven and then participate in the savings from the refinancing’s lower interest rate.

Less Interest, More Fulfilling?

Not only can homeowners possibly secure lower mortgage rates in today’s mortgage market, they also may be able to shorten their mortgage term.  Typically, 15-year mortgage rates are 0.50%-0.75% lower than similar 30-year mortgages.   Therefore, a borrower can refinance into a much lower mortgage rate by shortening mortgage terms and significantly reduce the amount of interest paid over the life of the mortgage.

To highlight this savings, see the table below for examples of a $200,000 mortgage loan. In this case, the borrower took out a 30-year mortgage 5 years ago at a 4.25% interest rate. With the recent drop in interest rates, the borrower has the option of refinancing into another 30-year mortgage with a 3.60% rate or a 15-year mortgage at a 3.00% rate (note that mortgage rates have gone up approximately 0.25-0.50% in just the past week of this blog date).

    Source: Bankrate.com

If the borrower refinanced into another 30-year mortgage, they would save $170 a month and still pay about the same total interest compared to their current mortgage. If they choose a 15-year mortgage, while their monthly payment would increase by $300 per month, they could save $76,000 over the term the mortgage.  So, while most potential refinancers focus on the estimated monthly savings, it’s also important to understand the total interest paid during the life of the loan.

Reasons Not To Refinance

Other key considerations for refinancing include the restricted ability to deduct mortgage interest given recent tax law changes. Also, some borrowers may choose not to pay an extra $300 per month with the 15-year mortgage and invest the $300 every month in the stock market with the goal of earning a higher compounding rate of return longer-term for college and/or retirement savings

Other important factors to consider are how old the mortgage is (banks frontload interest over the mortgage’s term) and how long one expects to own the house. If you’re planning on moving in a few years, refinancing may not be the right decision despite a much lower possible mortgage rate. Why? Despite lower projected monthly payments, there may not be enough time to offset the sunk closing costs.

So Should I Refinance?

The mortgage refinancing decision depends on a number of factors that are appropriate for your individual circumstances. Mortgage refinancing can be a smart choice and can help tackle important stuff like paying down debt and focusing on saving for college and retirement given a lower payment.  With current mortgage rates near historic lows once again, understanding your options with a refinancing makes sense since the current low rate environment may not be around much longer.

David Hone, CFA