When Mortgage Rates Fall, Is It Time to Refinance Your Home Loan?

Many people see a drop in mortgage rates as the perfect time to buy a home.

A lower rate means they’ll pay less interest on a home loan, and get more house for their money. 

But interest rate declines don’t only benefit homebuyers. They can also benefit homeowners. 

So if you’re interested in a lower mortgage rate, yet you don’t want to sell your home, a mortgage refinance is worth consideration. 

How Does Refinancing Work?

Refinancing is the process of creating a new mortgage loan to replace your old loan. 

There are two types of refinances based on your needs.

Some people only apply for a rate/term refinancing (falling interest rate), whereas others seek a cash-out refinance. This also involves a new rate and term, but you’re also able to borrow cash from your equity. 

Now:

When mortgage rates drop, you can’t call up your lender and negotiate a rate reduction over the phone. This might work with a credit card, but it doesn’t with a mortgage loan. To change the terms on an existing mortgage, you have to refinance the loan. 

A lower rate is desirable because it helps you save money on the mortgage each month. Home loans include repayment of principal and interest. So your monthly payment isn’t only determined by how much you spend on a property, but also your mortgage rate.

Mortgage interest rates can fluctuate from year-to-year.

So if you purchased your house when rates were higher, refinancing to a lower rate could potentially save hundreds each month. Not only because of the lower rate, because also because you’re likely refinancing at a lower amount (assuming you don’t borrow cash from your equity).

For example, you might have an original mortgage balance of $250,000, yet you currently only owe $190,000.

What to Watch For When Refinancing?

While refinancing is an excellent way to get a lower rate, refinancing isn’t exactly cheap or free. 

Think back to when you applied for the original mortgage. You no doubt remember paying closing costs. These are lender and third-party fees paid on closing day. Fees include the appraisal, loan origination, discount points, title search, attorney expenses, and other costs. 

If you decide to refinance a mortgage, be prepared to pay closing costs again. These can range from 2 percent to 5 percent of the loan amount.

Now, some mortgage lenders may advertise a “no-closing costs” refinance. But in most cases, these aren’t true no-cost refinances. The lender may instead wrap your closing costs into your mortgage balance, reducing your out-of-pocket expense.  

Or, the lender may offer to pay closing costs on your behalf. But this often results in a slightly higher mortgage rate to compensate for their “generosity”.

You should also be cautious of mortgage scams. For the most part, many lenders are reputable. Even so, be leery of any company that contacts you via mail, email, or phone offering a home loan refinance program.

The person you speak with may sound legitimate, but the conversation could be a ruse to get your personal information (name, address, and Social Security number). The person then uses this information to steal your identity. So never share your personal information with anyone over the phone or email. 

Also, don’t believe a company that says it’ll refinance your home loan, if you pay an upfront fee. This is likely another trick to get money from you.

If you’re interested in refinancing your mortgage, contact lenders yourself, and only use lenders you’re familiar with. Start with your current bank and request a free quote. Next, request at least two quotes from additional lenders to compare terms and rates.

Pros and Cons of Refinancing

Refinancing makes sense for some people, but it doesn’t for others. Here’s a look at a few pros and cons. 

Pros

  • Get a cash-out refinance to pay off high-interest debt and credit cards, or use the cash for home improvement projects and other purposes

  • Get a lower mortgage interest rate, resulting in a lower monthly payment

  • Convert your adjustable-rate mortgage to a 15- or 30-year fixed-rate mortgage

  • Switch to another home loan program, perhaps from an FHA home loan to a conventional home loan

  • Remove someone’s name from the mortgage loan

Cons

  • You have to pay closing costs

  • You have to re-qualify for a new mortgage

  • Refinancing restarts your mortgage clock

Is Refinancing a Mortgage a Good Move?

Mortgage interest rates aren’t guaranteed to remain low forever, so logic might suggest refinancing before rates increase.

But you need to consider a few things when determining whether refinancing is a smart move for you.

What’s the breakeven point?

Most people refinance to reduce their monthly payment and save money. But since refinancing does involve closing costs, you need to consider your breakeven point before proceeding with a new loan. 

Breakeven refers to how long it’ll take to recoup your refinancing costs.

So if you paid $5,000 in refinancing costs and you’re able to save $250 a month, it’ll take about 20 months to breakeven.

Therefore, you should only refinance if you’ll live in the house for at least another 20 months.

What's your monthly payment after refinancing?

If you’re thinking about refinancing and borrowing cash from your equity, it’s important to have some idea of your new mortgage payment. 

A cash-out refinance will increase your mortgage balance.

So:

Even if you’re able to qualify for a lower mortgage rate, you could end up paying more on a monthly basis, depending on how much you borrow from your equity. 

Mortgage lenders can crunch the numbers and estimate your future monthly payment based on the mortgage balance, estimated interest rate, and mortgage term.

What repayment term should you choose?

When refinancing a mortgage, some borrowers decide to reset the clock with another 30-year mortgage term. This can result in the lowest monthly payment possible. 

But rather than automatically choose another 30-year term, first consider how far you are into your original mortgage term.

If you’ve already owned the home for 12 years and only have 18 years remaining on the home loan, it might make more sense to refinance into a 15-year term as opposed to a 30-year term. This way, your new payoff date will be close to your original payoff date.

But, of course, if you’re refinancing with the intent to drastically reduce your monthly payment, another 30-year term coupled with a lower interest rate can result in the most monthly savings. 

Before choosing a term, ask your mortgage advisor to provide monthly payment estimates based on 15-year and 30-year scenarios. A 15-year mortgage might be more affordable than you think.

How is your credit score?

Understand that refinancing requires applying for a new mortgage. So having an existing mortgage doesn’t automatically qualify you for a refinance. 

You’ll need an acceptable credit score, and you’ll have to verify your income and employment.

If your credit score has dropped since getting the original mortgage, you may not qualify for a low rate.

What If Mortgage Interest Rates Fall Further?

If you refinance now, there’s always a chance that interest rates will fall further. So you might ask: Should I refinance now, or wait for a better rate?

Unfortunately, there’s no way to predict how far rates will drop. Mortgage experts can give their predictions.

But the truth is:

Rates can increase at any time. 

What you can do is keep a close eye on rates to see how much they drop and then refinance as soon as rates start to move upward again. This way, you can get your new mortgage while rates are still relatively low. 

Once you decide to refinance, talk to your lender about locking in your rate.

At this point, you are guaranteed a certain interest rate for a specified period of time.

How Often Can You Refinance?

If you’ve refinanced a home loan in the recent past, you might wonder whether you can refinance again. 

The good news is that you can refinance as many times as you like. But you should only do so when it makes sense financially.

And only after you’ve broken even on a previous refinance. This might take between one and two years. 

As a general rule of dumb, you should also wait until you’re able to get an interest rate that’s 1 percent to 2 percent lower than what you’re currently paying. Or else refinancing might not offer any significant savings.

Final Word

Refinancing can help you get a lower mortgage interest rate and save you money each month. But it’s important to understand the costs associated with a refinance. 

Talk with your mortgage lender and request a free quote, and then get two quotes from other lenders. This ensures getting the most desirable rate and terms.

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