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Could Now Still Be a Good Time to Refinance Your Mortgage?
By Aly J. Yale MONEY RESEARCH COLLECTIVE
It’s been a banner few years for refinancing. Mortgage lenders processed a whopping $2.7 trillion in refinance loans in 2021 and $2.8 trillion the year before. At one point, refinances accounted for almost 70% of all mortgage activity.
Those days are over, though, and according to the Mortgage Bankers Association, refinances have plummeted. As of July 27, applications to refinance a mortgage were down 83% from a year ago.
It’s no wonder. Mortgage rates are now well above 5%. Compare that to the ultra-low rates seen a year ago, and it would seem there’s just very little incentive to refinance these days — at least for most homeowners.
Still, “Anything is possible,” Christian Plocica, COO of VIP Mortgage Group in Orlando, says. “It all depends on your individual situation.”
Refinancing may still make sense if your rate will drop a point
Most personal finance pros say that if you can reduce your interest rate by a full percentage point, then refinancing is smart. Given today’s rates, that’d mean you’d need a current mortgage rate of around 6.3% to make refinancing worthwhile.
Here’s how that might look: Say you have a mortgage balance of $200,000 and a current rate of 7%. Refinancing into a new 30-year loan at a 6% rate would reduce your monthly payment by $132 or $1,584 per year. (Use a mortgage refinance calculator to run the numbers for your specific scenario.)
If you have a current rate of 5.3% or higher, you might also benefit from refinancing — as long as you’re willing to get an adjustable-rate mortgage (ARM). These come with lower interest rates upfront (the average rate on a 5/1 ARM is 4.29% right now), but the rate can increase later on, sending your monthly mortgage payment up with it.
If you go this route, plan on refinancing or selling the house before your rate can increase. On 5/1 ARMs, your rate would adjust after your fifth year in the home.
“The issue here is that rates are rising and are likely to only go up in the next one to two years, meaning in year six, you will very likely be paying substantially more,” says Tom Smythe, professor of finance at Florida Gulf Coast University. “
In both scenarios — refinancing to an ARM or a new loan with a fixed rate — you would owe closing costs. These average around $5,000, according to Freddie Mac, but can vary widely depending on where you live, your lender and other factors.
To make sure these costs are worth it, calculate your break-even point. This is when the potential savings of a refinance surpasses your closing costs. In the above scenario, if closing costs were $5,000 and your monthly savings were $132, your break-even point would be around 38 (5,000 divided by 132). This means that your refinance would be worth it in 38 months — a little over three years down the road.
“If you see yourself living in that house for longer than three years, then refinancing makes sense,” Plocica says.
Refinance rates in context
Mortgage rates are certainly higher than last year’s, but context is important. The sub-3% rates we saw in mid-2021 were actually all-time lows — the lowest rates ever recorded.
If you go further back, though, mortgage rates have ranged anywhere from 18% (in the early 1980s) to 2.65%, which we saw in January 2021. So, while today’s rates are technically “higher” than the ones available over the last couple of years, they aren’t really that “high” — at least in the historical sense.
“It’s something that most people under 45 just don’t get,” Smythe says. “Rates are still at historic lows. I would argue that a ‘normal’ 30-year rate is about 7.5%, but we haven’t seen these rates for an extended period since the early 1990s.”
