by Maurie Backman, The Motley Fool
Now may be a good time to refinance — but only if you plan to stay in your home long enough to reap the savings involved.
If you’ve been following the news, you may have heard that mortgage rates hit a record low in July, and they’re still competitive as we ease into August. In fact, on August 2, the average rate for a 30-year fixed mortgage was 3.12%, and 2.77% for a 15-year mortgage. That’s great news for first-time homebuyers, but it’s also good news if you already own a home. The reason? You may be able to refinance your existing mortgage. But is that the right move for you?
How does refinancing work?
When you refinance any type of loan, a mortgage included, you swap an existing loan for a new one. The goal of refinancing is to snag a lower rate on your loan than you’re currently paying.
For example, imagine you already have a 30-year fixed mortgage with a 4.25% interest rate on it. If you’re able to refinance to a new 30-year mortgage with a 3.12% interest rate, you’ll lower your monthly payments.
But not all refinances result in lower monthly payments. In fact, if you swap a 30-year mortgage for a 15-year loan, your monthly payments will likely go up, even if the rate on your new loan is much lower. In this case, you’ll save money in interest over the life of your loan. And, you’ll get to pay it off sooner. As such, refinancing could make sense even if it doesn’t actually result in you paying less money month over month.
Should you refinance your mortgage right now?
Whether or not it pays to refinance your mortgage today boils down to two factors:
- Do you qualify for the best mortgage rates out there?
- Will you stay in your home long enough to actually reap some savings?
The higher your credit score, the more likely you are to snag a competitive refinance rate. But if your credit isn’t great, then refinancing may not make sense. That’s because if the rate you qualify for is comparable to the rate you’re already paying, there’s not a lot of savings to be reaped when we factor in closing costs.
And that leads right into our next point. When you sign a mortgage, you’re liable for closing costs – things like administrative fees, loan origination fees, and other fees your mortgage lender charges. Closing costs also apply when you refinance, and they can be expensive, equaling a good 2% to 5% of your loan amount.
Now, say you’re looking at $4,500 in closing costs, but refinancing also lowers your monthly mortgage payment by $150. In that case, you’d need to stay in your home for 30 months just to break even. If you have no plans to move in the next five years or even decade, refinancing makes sense. But if you’re only planning to stay in your current home another year or two, then it clearly isn’t worth it – despite the fact that mortgage rates are low right now.
The same logic holds if you’re refinancing to a lower mortgage rate with a shorter term. Swapping a 30-year fixed mortgage for a 15-year loan might increase your monthly payment by $300, but save you $20,000 in interest over the life of your loan. If you don’t stay in your home for very long, you won’t reap those interest-related savings.
Ultimately, it pays for some homeowners to refinance their mortgages right now, but that doesn’t apply universally. You need to think about whether doing so is a smart move for you. And if you are going to refinance, shop around with different mortgage refinance lenders to see what offers you qualify for. That way, you can compare your options – both in terms of mortgage rate and closing costs – and see what’s the most competitive.