Curve

Should I refinance for 0.25% lower rate? Or wait for 1% or more?

Erik J. Martin
The Mortgage Reports contributor

How much should I drop my rate when I refinance?

Mortgage interest rates have been falling lately. That makes it a good time to buy a home or refinance. The latter is especially true if you can save money due to low refinance rates.

But here’s an interesting question: Is it worth refinancing to reduce your rate by only a quarter percent (0.25%)? That may not sound like a lot. But even a 0.25% rate drop can add up to big savings under the right circumstances. Then again, refi closing costs can be steep. Those costs could outweigh savings earned from lower refinance rates.

Shop and compare refinance rates carefully. Do the math and determine what you’ll pay up front and over the course of your refinanced loan. The right deal could be worth pursuing.

Verify your new rate (Oct 15th, 2019)

Consider closing costs vs. total 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.”

ARM mortgage holders, homeowners with large balances could benefit

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.”

“Over five years, that adds up to over $19,000 in savings,” Ho notes.

Loan consolidation seekers can win, too

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.

Verify your new rate (Oct 15th, 2019)

Cash-out and home improvement loan applicants

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 they 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.

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.

Should I refinance for a small drop in rate?

The bottom line? It’s a good time to refinance when your probable savings is 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. But when lower refinance rates begin to rise, it’s probably a good idea to pull the trigger,” Ailion adds.

Start your refinance application now before rates start to rise.

Verify your new rate (Oct 15th, 2019)