Mortgage rates are nearly 1 percentage point lower than they were a year ago, allowing some homeowners to save money by refinancing.
The 30-year fixed rate fell to 5.99% on Monday from 6.96% a year earlier, according to Mortgage News Daily. According to the Mortgage Bankers Association, mortgage refinance applications rose 7% last week and were up 132% from the same week last year.
Many homeowners still hold mortgages at interest rates well below today’s levels, but the proportion is increasing, raising the cost of borrowing. According to Realtor.com, roughly one in five borrowers currently has a mortgage rate of 6% or higher, including those who have locked in a rate of 7% or higher for the past several years.
For such borrowers, “a 1% decline is a good indicator when considering refinancing,” says Rob Greenman, a certified financial planner in Portland, Oregon. Whether refinancing makes sense depends on how the one-time upfront costs compare to the long-term savings from lower monthly payments, he says.
Do the math before refinancing
Refinancing typically has one-time closing costs of approximately 2% to 5% of the loan balance, per bank rate.
To estimate whether refinancing makes sense, divide these closing costs by the amount you expect to save each month. The results will tell how many months it will take to recoup the upfront costs, said Joon Eum, a CFP in Beverly Hills, California.
If you don’t plan to stick around long enough to recoup these costs, refinancing may not make sense, he says.
For example, on a 30-year mortgage with a balance of $400,000, a one-point drop in interest rates from 7.04% could reduce your monthly principal and interest payments by about $263. If closing costs total 3% of the loan balance, or about $12,000, it would take nearly four years to break even.
Homeowners should also be wary of resetting loan terms. A refinance replaces an existing mortgage with a new loan and requires the borrower to choose a new repayment schedule. According to Experian, many people choose a new 30-year term even after several years of repayments.
While it may be tempting to extend your term to reduce your monthly payments, Umm says extending your repayment term can increase the total interest you pay over time.
Refinancing should support your broader financial goals, not just lower your monthly bills. If this increases flexibility, savings, or long-term security, it may be worth it. “If all you want to do is free up money, think twice,” Um says.
When refinancing, borrowers should aim to recoup their closing costs through monthly savings within 18 months to two years, said Melissa Cohn, regional vice president at William Labeis Mortgage. If your break-even timeline extends beyond that, it may make more sense to wait, she says.
Homeowners can use CNBC Make It’s mortgage calculator to estimate potential savings.
What’s next for mortgage rates?
Mortgage rates have been falling in recent months as the yield on the 10-year Treasury note, the benchmark that mortgage rates tend to follow, has fallen toward 4% from about 4.25%. Cohn said weak inflation data, geopolitical risks and expectations that the U.S. Federal Reserve could cut interest rates later this year contributed to the decline in yields.
He said this time of year also marks the start of a new year, when financial institutions often compete more aggressively for business.
What happens to interest rates in the future will be determined by future economic indicators. If inflation continues to cool and the economy slows, interest rates could fall. It could rise further if inflation picks up again. That said, mortgage rates “never move in a straight line,” Cohn said.
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