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Mortgage applications have increased recently as 30-year interest rates have fallen to their lowest level since March, according to data from the Mortgage Bankers Association. The data showed that 30-year fixed rates fell to 6.87% and mortgage applications rose 4%, while refinances increased 15%, reaching their highest level since August 2022. With many homeowners considering refinancing their mortgages as interest rates fall, let's consider whether the process makes sense.
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Is it a good idea to refinance your mortgage when interest rates drop? Two financial advisors suggest considering these factors before making a decision.
Find out how much you can save on your mortgage payment
“One of the main reasons for refinancing is to reduce your monthly mortgage payment,” says Taylor Kovar, CFP, founder of 11 Financial. “When interest rates fall, refinancing to a lower rate can reduce your monthly payment, freeing up cash flow to put toward savings, investments, and other financial goals.”
Before you decide to refinance your mortgage when interest rates drop, it's a good idea to calculate how much money you could save by going through the entire process. Because refinancing your mortgage can come with significant closing costs, it's important to make sure the savings are worth it.
Here's an example from CBS: If you paid $8,000 in closing costs to save $200 on your monthly mortgage payment, it would take 40 months to pay for itself: Some lenders will only tell you the monthly savings, so you'll need to gather all the relevant numbers.
Most experts would agree that refinancing is worth it if you can shave 1% or more off your current mortgage rate, but you'll need to calculate how much you'll save in monthly mortgage payments compared to your total closing costs.
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Consider how long you plan to stay at home
“If you plan on selling your home within the next few years, refinancing may not make sense given the costs associated with the transaction,” says Chris Urban, CFP, RICP, founder of Discovery Wealth Planning. “If you plan on living in it indefinitely, you'll definitely want to consider the financial benefits of refinancing.”
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If you plan to stay in your current home for a long time, refinancing your mortgage could help you save money on housing, but if you plan to move within the next few years, it might not make sense to go through the paperwork.
“Refinancing to a lower interest rate can save you money over the life of your loan by reducing the total interest you pay,” Kovar says. “This is a big advantage if you plan to stay in your home for a long time, and the cumulative savings can be substantial.”
Check your financial situation
“Lenders consider your credit score, income stability and debt-to-income ratio when approving you for a refinance,” Kovar said. “If you have a strong credit score and a stable financial situation, you may qualify for the best rates and terms.”
If your financial situation has improved since you bought your home, refinancing could get you better mortgage terms. If you've paid off debt, increased your income, and improved your credit score, you could benefit from the savings that refinancing can provide. Before you move forward, you'll need to make sure you have the right paperwork and that your financial situation is improving.
Find out more about refinancing your mortgage
“Financially, you'll need to consider the details of your current mortgage, particularly the interest rate, mortgage type and how that compares to what you'll be offered when refinancing,” Urban said.
Refinancing your mortgage isn't just about saving money on your monthly payments. You can also use a refinance as an opportunity to modify your terms. If you bought a home during the pandemic, you may have accepted less favorable terms.
“Another strategy is to refinance to a shorter loan term (say, from a 30-year to a 15-year mortgage) when interest rates are low,” Kober explains. “This may mean a higher monthly payment, but it could save you tens of thousands of dollars in interest over the life of the loan and help you build equity more quickly.”
If you currently have an adjustable-rate mortgage, refinancing to a fixed-rate mortgage can provide stability and protect you from future interest rate increases.
Don't ignore the role of housing in your financial planning
Urban suggested considering the role your home and its assets play in your personal financial planning. Since your home is likely your largest asset, you need to think about how refinancing will impact your future financial plans.
“Consider your long-term financial goals and how refinancing fits into your overall financial strategy. If you're planning on moving or paying off your mortgage in the near future, the savings from refinancing may not justify the upfront cost,” Kovar said.
Mortgage Refinance Calculator
According to data from The Wall Street Journal, the amount you can save by refinancing depends on when you bought your home. For example, someone with a $500,000 mortgage at 8% interest rate could save $500 per month by refinancing to 6.5%. But it's important to figure out your break-even point based on your monthly savings and the costs of refinancing.
“It's essential to calculate the costs associated with refinancing your loan, such as settlement costs, appraisal fees and prepayment penalties. These costs typically range from 2% to 5% of the loan amount. Compare these costs to the savings you'll get from refinancing to determine your break-even point (how long it will take to recoup the costs through lower monthly payments or a lower interest rate),” says Kober.
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This article originally appeared on GOBankingRates.com: I'm a Financial Advisor: Should I Refinance When Mortgage Rates Fall?