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The world of mortgage rates has been a whirlwind in recent years. Remember those meager rates we enjoyed for a while? Well, they took a sharp turn upwards in 2023, causing a dramatic slowdown in refinancing activity. However, with whispers of potential interest rate cuts from the Federal Reserve, homeowners locked in mortgages during the high-rate period wonder if they should jump at the chance to refinance.
This article delves into the current state of mortgage refinancing, analyzes the data, and explores three key signs that refinancing might be the right move for you.
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- A significant interest rate reduction (ideally 0.5% or more) compared to your current rate can lead to substantial savings over time.
- If you can afford to pay closing costs upfront, you’ll maximize your long-term savings from refinancing.
- Refinancing can be particularly advantageous if you have an FHA loan and can eliminate the mortgage insurance premium.
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3 Signs That Show It’s Time to Refinance Your Mortgage
The Refinance Market Slump: Numbers Don’t Lie
In 2023, we witnessed the lowest refinance volume in three decades. The first half of the year alone saw a mere $75 billion and $80 billion in refinanced mortgages nationwide, a far cry from the bustling market activity of the past.
Jeff Ostrowski, a housing analyst at Bankrate, attributes this decline to the significant rate hikes. He explains, “Because rates shot up so much over the past few years, refinancing activity has mostly disappeared.” However, there’s a tiny glimmer of hope. There was a slight uptick in refinancing activity in February 2023 compared to the previous year.
But hold on to your horses – Freddie Mac, a government-backed entity involved in the mortgage market, predicts that many homeowners might be content with their existing rates or find the incentive to refinance underwhelming.
When Should You Consider Refinancing?
As you wait for the Federal Reserve’s decision on rate cuts, here are three signs that refinancing could be a wise financial step:
Significant Rate Reduction Potential (Think 0.5% or More)
According to Chen Zhao, a senior economist at Redfin, a real estate brokerage website, the optimal time to refinance depends on when you purchased your home. Traditionally, experts recommend waiting for a percentage point drop in rates to make a meaningful difference in your monthly mortgage payments.
But here’s the good news: if rates decline by at least 50 basis points (half a percentage point) compared to your current rate, it’s a good idea to contact lenders and explore your options. Remember that factors like closing costs, projected monthly savings, and how long you plan to stay in your home should all be considered when making this decision.
“There are costs associated with refinancing, but they are often low compared to the long-term savings you can achieve,” says Zhao. While the future of Fed rate cuts remains uncertain, rates are unlikely to dip significantly below 6% in the foreseeable future.
Veronica Fuentes, a certified financial planner at Northwestern Mutual, advises against holding out for rates as low as those witnessed during the early stages of the COVID-19 pandemic. “We’ve been accustomed to thinking of mortgage rates around 2% or 3% as the norm, but that’s not necessarily the case anymore,” she explains.
Imagine you have a $300,000 mortgage with a current interest rate of 7%. Your monthly payment is roughly $1,893. If you refinance to a rate of 6.5% (a 50 basis point reduction), your new monthly payment would decrease to around $1,823. That translates to a saving of $70 each month – not a windfall, but a significant amount over the remaining life of your loan, especially if you plan to stay in your home for a long time.
Ability to Cover Closing Costs Upfront: Saving Money by Spending Money (Strategically)
Refinancing your mortgage is akin to taking out a completely new loan. This means you’ll incur closing costs, typically including appraisals, title insurance, and other fees. The total cost can vary depending on your location and lender.
According to CoreLogic’s ClosingCorp (a provider of real estate closing cost data), the average closing cost for refinancing a single-family home in 2021 was $2,375. Refinancing makes more financial sense if you can pay these costs upfront instead of rolling them into your new loan. Here’s why: opting to finance closing costs might lead to a higher interest rate, and you’ll end up paying interest on those expenses throughout the life of your loan. Essentially, you’d be paying interest on interest!
“You need to be strategic about how much you’ll save and whether refinancing makes sense financially,” advises Ostrowski.
Let’s analyze this further with an example. Imagine you can save $100 monthly by refinancing at a lower rate. However, the closing costs associated with the refinance total $3,000. If you decide to roll those closing costs into your new loan, you might have a slightly higher interest rate. Let’s say the higher rate increases your monthly payment by $20.
In this scenario, even though you’re saving $100 monthly from the lower interest rate, you’re also paying an additional $20 each month because you financed the closing costs. It would take you 150 months (3,000 / 80) to break even on the closing costs because you’re essentially negating some of your savings with the higher monthly payment.
However, if you can pay the $3,000 closing costs upfront, you’ll immediately save the complete $100 each month. So, the sooner you plan to stay in your home, the more attractive it becomes to pay closing costs upfront to maximize your long-term savings.
Ditching FHA Loans and Their Costly Mortgage Insurance
Refinancing might be particularly attractive if you secured your home with an FHA loan. While FHA loans are instrumental in helping first-time buyers achieve homeownership, they come with a mandatory mortgage insurance premium (MIP) that can add a significant cost burden. Most new FHA borrowers pay an annual MIP equal to 0.55% of their loan amount.
Let’s illustrate this with an example. Imagine you have a $328,100 FHA loan. This translates to an annual MIP of $1,804 (0.55% x $328,100), which breaks down to $150 monthly payments.
“If you have an FHA loan, refinancing for even a slightly lower rate can be beneficial, especially if it allows you to eliminate the mortgage insurance premium,” says Ostrowski. Even if the new interest rate isn’t significantly lower, refinancing to a conventional loan could save you hundreds of dollars annually by eliminating the FHA MIP.
The Bottom Line
Mortgage rates are higher than before, but refinancing might still be a good option! By carefully considering the abovementioned factors, refinancing could save you money in the long run. But remember, talk to a mortgage professional to see if it’s the right move for you.
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