How much lower of an interest rate is worth refinancing?
Mortgage rates are hitting record lows this week — as low as 3% for a 30-year fixed loan, according to some sources.
It might seem like refinancing right now is a no-brainer. But the thing is, rates have been low for months now.
If you just bought or refinanced in late 2019 or early 2020, you might be sitting comfortably between 3.5% and 4%.
So even if you could refinance and lower your rate 0.5 percent to the low 3s, is it worth it?
That depends on three things: Your closing costs, how long you’ll stay in the house, and how low of a rate you actually qualify for.
Find a low refi rate today. Start here (Mar 5th, 2020)In this article (Skip to…)
- Refinancing for a 0.5% lower rate
- Refinancing for a 1% lower rate
- Refinance rates today
- Knowing when to refinance
- Breaking even with closing costs
- What about a no-closing-cost refinance?
- Refinancing for debt consolidation
- Cash-out and home-improvement refinancing
Is it worth refinancing for 0.5 percent?
It might be worth it to refinance for 0.5 percent if you plan to keep your mortgage for the next five to ten years, or longer. Remember, when you drop your rate less you save a little less each month. So it takes longer to recoup your closing costs and start seeing real benefits.
For example, someone who has a $400,000 loan and 3.75% rate might refinance to 3.25%.
This would drop their monthly payments from $1,850 to $1,750 — saving them $100 per month or $6,000 over the next five years.
>> Related: Streamline refinance — get today’s rates with almost no paperwork
But their closing costs could easily cost $6,000 (1.5% of the loan amount) or more. So that person doesn’t start seeing savings unless they keep the mortgage longer than 5 years.
Refinancing for a 0.5 percent lower rate — example
| Loan balance | $400,000 |
| Current interest rate | 3.75% |
| New interest rate | 3.25% (-0.5%) |
| Monthly savings | $100 |
| Closing costs | $6,000 (1.5%) |
| Time to break even | 5 years |
| Worth it? | Yes, if you stay longer than 5 years |
The other time it might be worth it to refinance for 0.5 percent is if you’re switching from an adjustable-rate mortgage (ARM) into a fixed-rate mortgage (FRM), and you want to lock in a low rate for the long term.
Refinancing for 0.5% or less with an ARM or high loan balance
Many experts often say refinancing isn’t worth it unless you drop your interest rate by at least 0.50% to 1%. But that may not be true for everyone.
“Say you are refinancing from an adjustable rate to a 0.25 percent lower fixed rate. Here, refinancing may make sense. That’s especially true if you expect interest rates to increase,” says Bruce Ailion, Realtor and property attorney.
“Say you are refinancing from an adjustable rate to a 0.25 percent lower fixed rate. Here, refinancing may make sense.” — Bruce Ailon, Realtor & property attorney
A quarter-point rate drop may also benefit someone with a large principal borrowed.
“A large loan size may result in significant monthly savings for a borrower, even when rates dip by only 0.25 percent,” says Reischer.
To illustrate this point, ponder the following.
“Assume you have a $500,000 mortgage at a 4.5 percent rate. Your monthly principal and interest payment is $2,533, with a PMI payment of $250. So your total monthly payment is $2,783,” says Steven Ho, senior loan officer at Quontic Bank.
But you opt to refinance to a 4.25 percent rate. This would reduce your monthly payment to $2,459—a $324 savings monthly.
“Over five years, that adds up to over $19,000 in savings,” Ho notes.
Even if you pay 2% in closing costs on that $500,000 loan, your upfront cost is just $10,000. So you save almost twice as much as you spent on the refinance within the first 5 years.
Start your refinance application today (Mar 5th, 2020)Is it worth refinancing for 1 percent?
Refinancing for a 1 percent lower rate is usually an easier decision than refinancing for 0.5 percent.
Simply put, you’re dropping your rate by twice as much, so your savings are twice as big. And with bigger savings you’ll break even with your closing costs to start seeing money back in your pocket faster.
Take a look at the same example as above, but with a 1 percent lower rate instead of a 0.5 percent lower rate:
Refinancing for a 1 percent lower rate — example
| Loan balance | $400,000 |
| Current interest rate | 3.75% |
| New interest rate | 3.25% (-0.5%) |
| Monthly savings | $100 |
| Closing costs | $6,000 (1.5%) |
| Time to break even | 5 years |
| Worth it? | Yes, if you stay longer than 5 years |
The short answer here is: The more you can lower your interest rate, the better.
That’s why it’s crucial to shop around for the best deal when you refinance, just like you did when you first got your mortgage.
Comparing rates from a few lenders can bring your new rate down by those few decimal points that take a refinance from “not worth it” to “totally worth it.”
Shop refi rates with top lenders today (Mar 5th, 2020)Refinance rates today
Your refinance rate depends on your loan balance, credit score, lender, and more. So rates look very different from one borrower to the next. But just looking at averages, we can see that today’s refinance rates* are among the lowest in years.
>> Related: Get today’s live rates in your state
| Loan type | Average refinance rate |
| Conventional 30-year fixed-rate | 3.250% (3.250% APR) |
| Conventional 15-year fixed-rate | 3.500% (3.500% APR) |
| FHA 30-year fixed-rate | 4.250% (5.243% APR) |
| VA 30-year fixed-rate | 2.750% (2.926% APR) |
Knowing when to refinance
How much lower you can get your interest rate isn’t the only thing you should consider before refinancing.
The benefits, of course, can be huge.
A lower interest rate means you’ll have smaller monthly mortgage payments. And it often means you’ll save thousands (maybe tens of thousands) by the time your loan is paid off.
But you have to weigh those savings against the inherent downsides of refinancing:
- You have to pay closing costs, which are typically 2-5% of the new loan amount
- You restart your loan term from the beginning, usually for another 30 or 15 years
- If your new interest rate isn’t low enough, you might actually pay more interest in the long run because you pay it for a longer time
Plus, most people don’t actually stay in their homes long enough to pay their mortgages off.
So you should make sure the savings you calculate are realistic, based on the amount of time you plan to keep your mortgage.
This is all to say that the numbers in this article are only examples — use them as guidance, but make sure your refinance decision is based on your own loan details and financial goals.
>> Related: Three ways to know when to refinance
Consider closing costs vs. total refinance savings
David Reischer, attorney and CEO of LegalAdvice.com, says there’s a lot to consider here.
“The costs to refinance a mortgage are not insignificant,” he says. “But there’s a smart way to calculate whether it’s a good financial decision.
“That’s by comparing the savings earned from a lower monthly payment over the mortgage term with the closing costs.”
Expect to pay anywhere from 2 to 5 percent of your loan amount in closing costs when you refi.
Say you need to borrow $150,000. If the closing costs equate to 2 percent of the loan amount, that adds up to $3,000.
In this example, the amount you save via a lower rate, over your new loan’s term, should be greater than $3,000.
To estimate if it’s worth it for you, try this refinance calculator.
“Determining whether the total costs to refinance makes sense heavily depends on how long you plan to keep the loan,” says Tom Furey, co-founder of Neat Capital.
“Assume your ultimate refinance goal is to save money. If so, you’ll want to determine that your long-term savings exceed the costs to secure the refinance.”
No-closing-cost refinances can cancel out your savings
But wait, you say: I found a lender that promises a “no closing cost refinance.”
Truth is, you can’t get away from paying the closing costs, Furey says.
In a “no closing costs” loan, the lender will increase your rate enough to create a lender credit that covers the closing costs.
Or it will increase your loan amount to cover those closing costs.
“Most borrowers choose the latter—lumping the closing costs into the loan so they can receive the lowest possible rate. But that’s not always the best option unless you plan to stay in your home for at least several years,” adds Furey.
Dropping your interest rate a small amount might be good to consolidate debt
Another good candidate for a quarter-point interest rate drop refi? Possibly someone seeking to pay off high-interest debt by consolidating it into a refi.
“Imagine you have $20,000 in credit card debt. The interest on this credit card is 25 percent, which adds up to paying $416 a month just in interest,” Ho says.
Say your original mortgage balance was $500,000 at a 4.5 percent fixed rate, equating to a $2,533 monthly mortgage payment.
But you decide to roll your $20,000 in credit card debt into your mortgage refi.
You’ll now have a $520,000 mortgage balance and a monthly payment of $2,558 after refinancing to a 4.25 percent rate.
“Your mortgage payments go up $28 extra a month. But your overall savings would be $391 a month. That’s because you’re no longer paying 25 percent interest on the credit card debt,” adds Ho.
Refinance advice for cash-out and home improvement loans
Say you plan to take cash out during your refinance. Then, the decision to lower your rate by 0.25 percent via a refi gets more complicated.
“With a cash-out refi, your monthly mortgage payment may not go down,” says Reischer.
“But you can use the cash taken out to consolidate other higher paying debt obligations. Or it can be used to make needed home improvements.
“That can be a very good reason to do a cash-out refi—to make upgrades that will increase the value of your property.”
Also, think about refinancing to a shorter term—going from, say a 30-year loan to a 15-year loan.
“This can yield even lower refinance rates. And it can result in you paying less in interest payments over the life of your loan,” says Ailion.
>> Related: When to consider a 15-year refinance
Should I refinance for a small drop in rate?
The bottom line? It’s a good time to refinance when your probable savings are greater than the probable costs.
“If refinance rates are declining, it may pay to wait to maximize the difference between your current rate and the new rate,” Ailion adds.
“But when lower refinance rates begin to rise, it’s probably a good idea to pull the trigger,”
Start your refinance application now before rates start to rise.
Verify your new rate (Mar 5th, 2020)
