Mortgage interest rates have fallen to their lowest level in about a year and a half, and many people who bought homes within the past couple of years might want to start thinking about refinancing. The average 30-year mortgage rate peaked at nearly 8% in late 2023, but has fallen sharply in recent months, now sitting at about 6.15%. So, it’s fair to say that many recent home buyers could be able to save serious money.
With that in mind, here’s what you should keep in mind before deciding to refinance your mortgage, and if you might be better off waiting to see if rates plunge even further.
Two types of refinancing
Before we go any further, it’s important to realize that there are two different types of refinancing mortgages:
- Rate-and-term refinance: You’re obtaining a new loan of the same amount but with a different interest rate.
- Cash-out refinance: You’re obtaining a new mortgage with a higher loan amount. It has a lower interest rate, but the main reason most people use cash-out refinancing is to use some of the equity in their homes.
The mathematics of refinancing
With rate-and-term refinancing, the mathematics are rather straightforward. Since refinancing comes with closing costs, such as origination fees, recording fees, and others, the question is whether the savings will more than offset the costs.
As a basic example, if it costs you $4,000 in fees to refinance and it saves you $200 per month, you’ll break even on the fees after 20 months of making payments on your new mortgage. Of course, it’s a little more complicated than this, especially if you’ve been paying on your existing mortgage for several years, but that’s the basic idea.
With a cash-out refinancing, it’s a little more complicated and depends on your personal situation. There are some obvious situations — for example, if you have a 7% rate on your current mortgage, can do a cash-out refinancing at 6%, and you plan to use the proceeds to pay off credit card debt at 25% interest, it’s an easy call.
On the other hand, some situations can be more difficult. Consider the same situation as above, but let’s say that your existing mortgage rate is 4.5%. Would it still be worth a cash-out refinancing to get rid of higher-interest debts, or would a home equity loan or HELOC be a better option?
What if rates keep falling?
I have a friend who bought a home last year and has a mortgage rate of about 7.5%. He doesn’t have any need to take equity out of the home, but a simple rate-and-term refinancing makes a lot of mathematical sense. On a roughly $400,000 home, refinancing would cause his mortgage payment to drop by $267 per month and he would more than recoup the origination fees within a year.
However, the biggest pushback he gives is, “Sure, but what if rates keep falling?”
He has a point. The Federal Reserve is widely expected to continue lowering the federal funds rate, and most experts project mortgage rates will reach the mid-5% range within a year or so. But there are two things to keep in mind.
First, there’s no guarantee that mortgage rates will actually continue to fall. Predictions are exactly that — predictions. How many experts do you think called for mortgage rates to more than double during 2022? Nobody knows for sure what will happen.
Second, there’s no rule that says you can only refinance once. I know someone who refinanced three times during 2020 and 2021 as rates plunged. If you refinance now, and a year from now rates have fallen another full percentage point, there’s no reason why you can’t do it again.
The bottom line
If you have a relatively high mortgage rate — say 6.75% or higher — it could be worth crunching some numbers to see how much money you could save by refinancing. Check out some of our top refinancing lenders, many of which will allow you to check your personalized rate offers without a hard credit check.
Of course, refinancing isn’t the right move for everyone reading this, but for many recent buyers, it could at least be worth it to start keeping an eye on mortgage rates.