With mortgage rates now down to nearly 6 percent, a growing number of homeowners could benefit from refinancing.
But does it make sense to you?
The vast majority of homeowners with mortgages still have enviable interest rates in the fives or lower. However, according to data from ICE Mortgage Technology, at least four million borrowers could potentially save 0.75 percentage points on their current interest rate by refinancing at current rates.
And there are around 1.7 million homeowners who are doing particularly well: These people have interest rates of 6.92 percent or higher, a credit rating of 720 or more and at least 20 percent equity in their homes; Combined, that means they can now save an average of about $334 per month by refinancing.
Here you will find out what you need to consider.
How mortgage interest rates work
According to Freddie Mac, the average interest rate on 30-year fixed-rate mortgages was 6.22 percent as of Thursday, up slightly from 6.17 percent last week and 6.79 percent a year ago.
After being above 7 percent at the start of the year, interest rates have generally declined, particularly in recent weeks, driving up the number of refinancings.
Mortgage rates do not move in step with, but are influenced by, the Federal Reserve's changes to so-called federal funds rates (the interest rate that banks charge each other for overnight loans). Instead, mortgage rates are largely based on the 10-year Treasury yield, which depends on a variety of factors, including the inflation outlook, the economy and investor sentiment.
If the economic growth outlook weakens, longer-term interest rates, including for mortgages, are likely to fall.
This is how refinancing works
Refinancing involves paying off your existing mortgage and taking out a new loan. Refinancing from one 30-year loan to another typically results in lower payments, freeing up cash for other expenses or savings. However, you may end up paying higher interest rates over time (although additional payments toward the loan amount may shorten the overall term of the loan).
Conversely, a mortgage with a shorter term – say 15 or 20 years – may result in more interest savings, but your payments will be higher.
Do math
Although many more borrowers are now refinancing, some are still waiting because they expect interest rates to fall even further, which is entirely plausible but cannot be predicted with certainty.
Refinancing only makes sense if you expect to stay in your home long enough to pay off the closing costs and other fees, which are often a flat $2,500 to $4,000 or perhaps 2 or 3 percent of the loan amount, depending on the mortgage size and your location.
Let's say the refinance costs $2,500 and you'll likely reduce your payments by $250 per month. If you divide $2,500 by $250, that means it will take 10 months before you can get your money back and start saving.
“While there is no hard and fast rule — simply a personal decision — the general rule of thumb is that the payback period should be 36 months or less,” said Kevin Iverson, president of Reed Mortgage, a brokerage firm in Littleton, Colorado.
Then there is the question of monthly cost savings. In years past, the common wisdom was that you shouldn't refinance unless you could lower your interest rate by at least one percentage point — but that's no longer true.
“This is very old fashioned as loan amounts have become much larger over time and you don't necessarily need a percentage point reduction to achieve significant savings with a reasonable payback period,” Mr Iverson added. However, smaller loan amounts require significant interest rate reductions to be worthwhile.
Using a mortgage refinance calculator like the one on Fannie Mae's website, you can enter your current payment and a new interest rate for each potential refinanced mortgage to see the potential savings.
If you are unsure
For people who are afraid to move forward because they expect interest rates to drop further, some lenders offer what's called low-cost or no-cost refinancing. You don't pay nearly as much up front, but you still pay something – in the form of a slightly higher interest rate. That gives borrowers the opportunity to refinance again if rates become more attractive — and it could be a good option for borrowers who don't expect to stay in the home long enough to recoup their closing costs.
“A consumer with short-term goals will often choose the free option,” said Erik Johansson, senior loan officer at Rocket Mortgage in Palatine, Illinois.
Find the best tariff
Before you start shopping, check your credit records with each of the three credit bureaus to make sure there are no inaccuracies. You can get free copies at annualcreditreport.com, which is run by the Big Three.
Start by contacting your loan servicer — they may offer competitive deals to retain their current customers, brokers say.
But as tedious as it may be, take the time to look around. As my colleague Ann Carrns reported this year, contacting different lenders to compare costs can save borrowers thousands of dollars in the long run.