Current homeowners who purchased a property in the last several years may be on the lookout for declining interest rates. The opportunity to refinance a home loan into a lower interest rate with a similar or extended repayment term can result in hundreds of dollars in savings for some, at least in the short-term.
However, mortgage refinancing is not always the best financial move for everyone, particularly when considering the cost of doing so. It’s not always clear if you should refinance yours.
The considerations around refinancing are coming to the forefront now as mortgage rates drop. Over the last year, interest rates on new mortgage loans have moved down to an average of 2.96% for 30-year conventional mortgages and 3.40% for jumbo loans. The decline is significant given that mortgage loans are repaid over 30 years in most cases, but it is enough to jump on the refinancing bandwagon?
Here are several things to think through before home mortgage refinancing in a declining interest rate environment.
When Home Mortgage Refinancing Makes Sense
Refinancing a home loan is a relatively simple process that involves taking out a new mortgage to pay off the original, often with a new lender. When homeowners refinance, the reasons behind such a significant financial move are varied, typically including the following advantages:
- Reducing the interest rate on the loan
- Reducing the monthly payment on the loan
- Locking in a shorter repayment term with a lower annual percentage rate (2.40% APR on 15-year mortgages as of today)
- Taking cash out of the equity in the property without a home equity loan or line of credit
The most common reason for refinancing is a reduction in the interest paid on the loan.
For example, refinancing a $200,000 30-year mortgage with a 4.5% interest rate down to a loan with the same term but a 3.5% rate can result in savings of more than $41,000 in interest payments over the life of the loan! All things equal, it also reduces the monthly payment (principal and interest only) down by nearly $150.
This extra cash both immediately and over the long haul can add up to significant savings for homeowners who refinance at the right time – and the right rate.
Cash-Out Mortgage Refinancing
Some homeowners may also benefit from refinancing when interest rates are lower when they have built up equity in their homes. A cash-out refinance is the process of taking out a mortgage larger than the current balance owed on the original loan, and having the difference paid out in cash. This can be a more affordable way to tap into home equity compared to a home equity loan or line of credit.
When interest rates are lower than the original mortgage loan’s APR, the monthly payment for the new refinanced loan with the added equity in the balance can be lower, the same or slightly higher than the current loan payment depending on the terms you want or need.
Each of these benefits can help homeowners save money with the help of a refinanced mortgage. However, there are plenty of reasons to stick with a current mortgage loan too.
Reasons Not to Refinance Your Home Loan
Refinancing sounds good on the surface, but homeowners need to be fully aware of the costs associated with the process.
You’ll Have to Pay Loan Closing Costs…Again
First, refinancing almost always means paying new closing costs, which can range from 3 to 6 percent of the total loan. On a $200,000 loan, this equates to $6,000 to $12,000. Many lenders allow homeowners to roll these costs into the new loan, so cash may not be required upfront.
However, adding more to the mortgage loan and financing that amount over the course of 30 years can add substantial interest charges, even if you lock in a lower rate.
You’ll Start Over With Your New Mortgage Loan
Additionally, refinancing a home loan that you have already been paying on for a few or several years resets the repayment term.
Let’s say you have an original mortgage with a 30-year term and have been in the home for five years. If you look closely at your mortgage statement, you see you are now paying less in interest and more toward principal, compared to the first year of the loan.
Refinancing means you reset the clock, and you are making less headway on the principal balance. Some lenders may allow you to refinance into a loan with a shorter term, such as 10, 15, 20 or 25 years, which helps make up this difference. However, this strategy is less likely to reduce your monthly payment.
Final Thoughts on Refinancing Your Mortgage Loan When Interest Rates Drop
In a declining interest-rate market, like the one we are in currently, it is easy to be enticed by the idea of refinancing, especially if you can lock in a lower rate. However, it is essential to crunch the numbers to ensure taking out a new mortgage loan, with its closing costs and repayment term considered, makes the most financial sense.
If you’re struggling to make the comparison on your own, use a refinance calculator and speak to a mortgage broker, bank, credit union or other loan officer to review your options, and get the total cost estimate of getting a new home loan. Interest rates dropping is almost always a good thing for homeowners, but the decision to refinance or not isn’t always clear.
