The huge drop in interest rates over the past several months means you might want to be thinking about refinancing your mortgage. The average rate for a 30-year fixed-rate mortgage has dropped from a recent high of about 5.0% in November, 2018, to below 3.75% today. This is quite a drop in a short period of time, and it reflects a number of factors, including a deceleration in economic growth, decreasing inflation, and the expectation that the Fed might engage in another round of short-term interest-rate cuts very soon. But the bad news for the economy could be good news for you!
JP Morgan bank analyst Vivek Juneja wrote in a note published this morning that “based only on rates, nearly half of mortgages outstanding are estimated in the money to refi.” Of course, just because mortgage rates are now a bit lower than your current rate doesn’t mean it necessarily makes sense to refinance. There are other considerations, like the amount of the fees you will need to pay (which generally approximate 1% of the loan amount), how long you expect to stay in the home, and whether you need to pay any “points”, which are essentially a commission for the mortgage broker. But if the difference between your existing mortgage rate and current mortgage rates is large enough, you could stand to lower your monthly mortgage payment by a significant amount.
Let’s go through an example to show how valuable a mortgage refinance can be. Let’s assume that you currently have a mortgage with a $400,000 balance, which you used to buy a house last November. The rate on your mortgage is 5.0%, which was roughly the average rate during November of last year. We assume that you can obtain a new mortgage for $400,000 at a 3.75% rate, but you must be willing to pay closing costs of 1.0% of the loan and a broker fee of 0.5% of the loan. (In many case you won’t have to pay a broker fee at all, but your mortgage rate may be slightly higher.) In the chart below, we show the cumulative interest savings over the life of the new loan, assuming an up-front payment of $6,000 to cover the closing costs and broker fees (1.5% total). You will see that you are able to recover the $6,000 in fees very quickly (in month 15, to be exact). You will also see that the cumulative savings over the life of the loan grow to over $90,000. Of course, this assumes you stay in the house for the next 30 years. However, you obviously don’t have to remain in the house that long to reap significant savings. If you stay for just 10 years, for example, your cumulative savings would be over $37,000.