After a period of mortgage rates being persistently high, they are finally starting to fall. In the week of Aug. 8, 2024, mortgage rates fell “to their lowest since February 2023,” said NerdWallet. And there’s a good chance that “rapid decrease is likely to set off a wave of refinancing.”
Refinancing your mortgage can allow you to secure a lower rate — particularly if you took out your loan when rates were higher than they currently are. But is it a good idea for you?
When should you refinance your mortgage?
There are a few scenarios where refinancing your mortgage could make sense:
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It will allow you to get a lower interest rate. You might refinance if doing so will allow you to lower your interest rate, either because “interest rates have dropped since you first obtained your mortgage” or “your credit score has improved since taking out your current loan,” said Bankrate. Ideally, your new rate will be “one-half to three-quarters of a percentage point lower than your current rate” to offset costs associated with refinancing.
You want to change your loan term or structure. Refinancing can also make sense if you’d like to change your loan’s term or structure. For instance, maybe you want a longer repayment term to lower your monthly payments or maybe you want a shorter term to lower the amount you’ll pay in interest. Or, maybe you “have an adjustable-rate mortgage that’s about to convert to the variable-rate period,” in which case “you could refinance to a fixed-rate loan to guarantee predictable monthly payments,” said Bankrate.
You’d like to eliminate private mortgage insurance (PMI). By refinancing, “you may be able to accelerate removing mortgage insurance,” said CNN Underscored. That’s because when you refinance, the lender “will look at the current appraised value of the home, which may be different from its value when you took out the original mortgage,” and “if you’ve built enough equity, you can refinance to eliminate PMI.”
When does it make sense to hold off on refinancing?
That said, refinancing is not always the right move. You might skip it in the following scenarios:
You already have a mortgage rate under 5%. Sometimes a good thing is better left alone. If you “have a mortgage rate under 5%,” then “refinancing probably won’t be cost-effective in the near term,” said CNN Underscored. Another reason to steer clear is if your credit has taken a hit recently, as “you’re unlikely to qualify for better terms than you have now if you’ve had some credit mishaps since you got your mortgage.”
Your mortgage has a penalty for prepayment. Given you already have to pay closing costs when you refinance, adding a prepayment penalty to the mix “may negate the value of refinancing,” said CNN Underscored. Not all lenders charge it, but some do charge this fee “for paying off your loan ahead of schedule, typically in the first few years.”
You may sell soon. Thinking about selling your home in the near future? You may want to rethink refinancing. That is because “the costs associated with refinancing will outweigh your savings unless you plan to stay in the home past the break-even point,” said CNN Underscored.
What to keep in mind before refinancing
While you may have your eye on the prize (in this case, a potentially lower mortgage rate), it is important to consider all angles before moving forward with refinancing, as it carries pitfalls as well as advantages.
For starters, “refinancing loans have closing costs just like a regular mortgage,” said CNBC Select. For these, the mortgage lender Freddie Mac “suggests budgeting about $5,000.” You might see some lenders promising a “no-cost refinance,” but that “usually just means the closing fees are being wrapped up into the amount of your loan,” said CNBC Select. So before you go full-steam ahead, crunch the numbers to make sure the amount you will save by refinancing exceeds the amount you will spend to do so.
It is also worth noting that as with any type of loan, applying for a mortgage refinance loan will cause a “slight dip” in your credit score, though it will be “only temporary,” said CNBC Select. That is because “the lender will perform a hard inquiry to evaluate your creditworthiness.”
