As a result of the pandemic and its effect on the economy, interest rates have fallen this year. At the beginning of January 2020, the average rate for a 30-year fixed mortgage was 3.7%, but this year it hit record lows, even dropping to 2.78% percent in early November. Many people have refinanced or are considering refinancing their homes.
We refinanced our home earlier this year and are in the process of doing it again.
Below is a summary of my experience, what we will gain from the refinance, as well as a few questions that can help you decide whether you should refinance.
Here’s why we decided to refinance.
In March 2020, the 30-year fixed-rate mortgage dropped to 3.29% and hit a historic low for the first time since Freddie Mac started tracking it in 1971. After watching the rates for a couple of weeks and shopping around, we decided to refinance at a 3.125% interest rate. We purchased our current home in the summer of 2018 when the average rate on 30-year mortgages was slightly over 4.5%. At the time, we locked in a 4.25% interest rate on a 30-year term. Before refinancing, we planned to pay off our mortgage early by making extra payments towards our principal.
We saw this refinance as an opportunity to secure a better rate and build equity more aggressively in our home.
We opted for a no cash-out 20-year refinance option. For less than 50 dollars extra in mortgage payments a month, we lowered our interest rate by more than one percentage point and reduced our mortgage term by eight years.
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Six months later, we decided to refinance again…here’s why
Hindsight is 2020; if we knew rates would have continued to reach historic lows, we would have waited a little longer before refinancing. But back in April, there was no guarantee that rates were going to continue to drop.
We received a significant lender credit during the first refinance, which resulted in a close to free refinance for us.
We are refinancing again because after analyzing the numbers, it made sense for us financially. To justify going through this process twice in six months, we wanted to make the most out of it and shave a few more years from our mortgage term again.
We opted for a 15-year no cash-out refi with this refinance, and our mortgage interest rate will drop by approximately another point to just over 2 percent.
We will receive another lender credit, and our closing costs will be less than $2,000. We will once again recoup most of that after closing.
What did we gain from refinancing?
With this refinance, we will accomplish three key things.
- We lowered our interest rate from about 4 percent to around 2 percent, which increased the rate at which we are building equity in our home.
- We reduced the term of our mortgage by 13 years.
- We saved six figures in interest that would have been incurred over a 30-year mortgage term.
How much did it cost?
As a result of refinancing, our family traded a 30-year mortgage for a soon to be 15-year mortgage and lowered our interest rate by about 2 percentage points.
Once the second refi is processed, we would have spent less than $2,000 total, which will be recouped after staying in our house for a year. While we had the option to refinance to another 30-year mortgage, it did not fit with our long-term goals. We chose to shorten the term, which will result in a slight increase in our monthly mortgage expense. While it might not make sense for everyone, it did for our family.
If you purchased a house in recent years with a mortgage, refinancing is worth looking into. It can allow you to lower your mortgage interest rate or shorten the term of your mortgage. If you have an adjustable-rate mortgage, this is a great time to switch to a fixed-rate mortgage as well.
Should you refinance your house?
Below are questions that can help you decide what to do.
Why do you want to refinance?
Do you want to refinance to lower your interest rate or shorten your mortgage term to build more equity in your home with each mortgage payment?
If the numbers make sense, then that’s something to consider.
Do you want to refinance to access the equity in your home to pay off debt?
Most people who refinance to pay off high-interest debt tend to get into more debt in the future. Will you have the discipline to withdraw exactly what you need to pay off your high-interest debt and not fall into the trap of incurring more debt?
Do you want to refinance to access the equity in your home to renovate your home?
If you are thinking of taping into your home equity to renovate your home, it’s a decision that you should not take lightly if it results in increasing the term of your mortgage. While it might be a good decision if you are selecting upgrades that will result in a higher home value, it does not always make sense, depending on the cost.
Do you have good credit?
In these times, many people are applying to purchase or refinance a home; having good credit will ensure that you will qualify for the best rates and terms. This year, we received over $5,000 in lender’s credits and waivers, which significantly lowered our closing costs.
If you have good credit, look at current mortgage interest rates to ensure that you get the rates/ terms you should qualify for based on the market. Having good credit will also allow you to be eligible for all of the incentives that lenders offer.
Do you plan to own the house long enough to recover the costs to refinance?
Refinancing comes at a cost. The average refinance closing expense in the US is around $5,000. While it is fair to estimate between 1 to 2 percent of the loan amount in closing costs, the final cost is affected by your home’s size and the county you live in. In our experience, our out of pocket cost for each refinance will be less than $1,000 after credits and escrow refunds. It represents less than 1 percent of the loan amount.
To justify the expense, we would need to own our home for approximately one year.
It is essential to shop for the best deal you can get, not just the best rate. Try to lower the refinance cost as much as possible by comparing the different options lenders offer you. Once you have chosen the best option, make sure that you plan to stay in the house past the break-even point, which is when your interest savings will exceed the cost of refinancing.
How much will you gain from the refinance?
Refinancing your home might make sense if you can reduce your interest rate by at least one percentage point. Take the time to analyze the numbers to determine how much you would gain from the refinance compared to the expense.
Refinancing your home can be an excellent decision for various reasons. However, to take full advantage of this opportunity, the refinance terms have to be beneficial to you, and you should plan to own the house long enough to recover the cost of refinancing.
If refinancing is not a good option for you right now because you need time to work on your credit or save for the closing costs, you can work towards that goal in the near future.
The good news is that the Federal Reserve announced its plan to keep interest rates low until probably 2023. While the Federal Reserve usually doesn’t directly determine mortgage rates, its decisions impact the economy, which impacts mortgage rates. However, since March 2020, the Federal Reserve has purchased $1 trillion of Mortgage Back Securities, which directly affects mortgage rates.
With the promise of a COVID-19 vaccine on the horizon, interest rates are likely to increase but, with the Federal Reserve’s desire to keep the rates low, we will most likely continue to see low-interest rates for at least another year.
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“The paid-off home mortgage has taken the place of the BMW as the status symbol” Dave Ramsey
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