With Such Low Interest Rates, Should You Refinance?
As hard as the COVID-19 pandemic has been on the economy, you still have opportunities to improve your finances. In particular, record-low interest rates can make now a great time to refinance your mortgage.
In doing so, you can reduce the amount of interest you pay over the life of your home loan while also taking advantage of potential benefits such as changing the duration of the loan or completing a cash-out refinance.
However, refinancing can have drawbacks, so you should carefully assess your options before diving in.
Why Refinance Your Mortgage?
You can end up paying lower interest rates through refinancing a mortgage, which involves taking out a new home loan to pay off your existing mortgage. The savings depend on how much lower the interest rates are for your new loan compared with the old one, as well as the terms of the loan.
Now could be an opportune time to lock in low interest rates. The average 30-year, fixed-rate mortgage rate hit a record low of 3.23% as the end of April 2020, according to Freddie Mac. In comparison, rates were as high as 4.94% in November 2018.
This drop has been occurring over the past year and a half, though the pandemic drove rates lower. As pandemic-related shutdowns started in mid-March, the Federal Reserve cut the federal funds rate to 0-0.25% and maintained that position during its end-of-April meeting.
Moreover, the central bank has been purchasing debt securities during this challenging period, which injects liquidity into the market and drives down long-term interest rates.
That means there’s more opportunity to qualify for a lower interest rate if you refinance your mortgage, although the specifics will vary on when you took out your original mortgage and the conditions of the loan. Even if refinancing extends your term, you might end up paying less over the life of the loan due to the reduced interest rate.
If you’ve been paying down your mortgage for several years or if you can afford a higher payment, you might not want to refinance to a 15-year mortgage rather than a 30-year home loan. Even though choosing a shorter term increases your monthly payment, you will pay less in interest over the life of the loan. The savings could help you come out ahead while paying off your mortgage faster.
Risks of Refinancing
While refinancing can yield savings in many cases, there are still risks to keep in mind. Primarily, refinancing includes closing costs and other fees that can drive up the cost of the loan. You want to assess the numbers to make sure that refinancing does not end up costing you more overall.
In general, expect refinancing-related fees to account for at least 2% of the total loan, with the potential to be a few percentage points higher depending on the specifics of the loan and the parties involved.
If your credit score has fallen since you took out your original mortgage, you might not qualify for a low interest rate. You can try to counter this by shopping lenders to find more competitive offers.
There’s also the potential for interest rates to fall further, but considering they’re hovering around record lows, there might not be much more room to fall.
Speaking with a financial advisor can help you determine if taking out a new mortgage makes sense for your financial picture. Our Roseville, CA financial planning firm partners with clients throughout the Sacramento area to determine whether a refinance works for them as part of their overall plan and goals.
Schedule a complimentary, 15-minute call with a fee-only financial advisor today to discuss your personal situation.
This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor serving the greater Sacramento area with an office in Roseville, CA. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country's leading professional association of fee-only financial advisors.