Question: How much should I wait for rates to drop until I refinance my loan?
Answer: Mortgage rates have fallen (and risen) over the past six months. A few weeks ago rates were down by over 1% from earlier this year and at 18-month lows which meant anybody who took on a mortgage recently should be thinking about refinancing. Rates have come back up over the past couple of weeks, but I wouldn’t be surprised to see them sink again in the coming months.
I reached out to loan officer, Jake Ryon at First Home Mortgage to ask about the process he uses to help clients decide whether it’s the right time to refinance.
What Are Your Goals?
The first step is understanding what you want to achieve. Ask yourself:
- Do you want to lower your monthly payments?
- Do you want to shorten or extend your loan term (e.g. 30-year to 15-year)?
- Do you want to take cash out for home improvements or other financial goals?
Since most people refinance to lower their monthly payments, I will focus mostly on that decision.
How Much Does a Refi Cost?
The transactional cost of refinancing varies, but Jake advises estimating 0.5%-0.75% of the loan amount to refi in Northern VA (usually on the higher end of the range), but these costs can vary based on several factors and vary by state/city. The transactional costs include things like:
- Lender fees
- Title fees
- State taxes/fees (e.g. recording fee, transfer tax)
- Third-party fees (e.g. HOA questionnaire, appraisal)
When refinancing into a new loan, you must re-establish your escrow account (property taxes and insurance) and pay interest on both the old and new loan. Jake usually excludes these costs in his calculations because these are not costs specific to refinancing since you pay escrows and interest whether you refinance or not. You’ll get an escrow refund from your current servicer (mortgage holder) so it’s effectively an exchange of dollars.
Prioritize Break-Even Point Over Interest Rate
While getting a lower interest rate gets the most attention, the break-even point is what really matters. The break-even point is the time it takes for your savings on monthly payments to exceed the costs of refinancing.
For example, if refinancing saves you $300 per month and you’ll pay $3,000 in transactional costs, the refinance is profitable after 10 months. If you break even within 12 months, refinancing usually makes sense. If the break-even point is under 6 months, it’s a no-brainer.
To shorten your break-even period, consider low or no-cost refinancing options by building your transactional costs into the new mortgage through a lender credit.
Timing Matters
Refinancing early in your loan period is ideal because your payments are mostly interest so refinancing early can significantly lower your total interest paid over time, even if you refinanced recently.
However, if you’re 15 years into a 30-year mortgage, your monthly payments have gotten very productive because most of the payment goes towards principal. Refinancing at this point might lower your monthly payment but it will stretch your loan term out, meaning you’ll likely pay more total interest in the long run. This is not necessarily a bad thing, but something to consider about the timing of refinancing or consider refinancing into a shorter loan term like a 15-year.
Other Factors to Consider
There are a host of other factors to consider with a loan officer that may significantly improve your mortgage terms that are not just based on interest rates:
- Better Credit Score: If your credit score has improved enough since you applied for your current mortgage, your rate may be lower just because of your improved credit score
- More Equity (remove PMI): More equity in your home can help you get better terms or remove private mortgage insurance (PMI) if your loan-to-value ratio improves
- Adjustable-Rate Mortgages (ARM): If you have an ARM, refinancing into a fixed-rate mortgage may be smart if you’re concerned about rates rising in the future
Contact a Lender to Work on Numbers
You do not need to refinance with the same bank that currently holds your mortgage or that you originated your mortgage with, so feel free to reach out to any lender to run numbers for you. Jake Ryon at First Home Mortgage is a great local lender who can help you analyze the decision and put the right strategy in place if now isn’t the right time. You can email Jake at [email protected] to get started.
If you’d like to discuss buying, selling, investing, or renting, don’t hesitate to reach out to me at [email protected].
