It's hard to miss the news stories calling out our "historically low mortgage rates" and not feel some FOMO. The question is - should you refinance now or wait for even lower rates? Let's take a deeper look at what is happening and how you can make a decision about refinancing.
Are Mortgage Interest Rates Really At An All-time Low?
Mortgage rates are low, but will they continue to stay low? The easy answer is that no-one really knows. There are many predictions that mortgage rates will stay low for quite some time, and others say take advantage of the low rates today. If we look at historical data from the Federal Reserve Bank, low rates don't stay low for too long.
However, we have also reached a never before seen low, and so historical data may not be able to tell us what 'historically' happens!
What we do know is that interest rates are set by a combination of factors. The Federal Reserve Bank (FRED) sets the interest rate for lending money to financial institutions and banks in order to stimulate or restrict the economy. The rate the FRED sets is not the rate you receive. Based on the FRED number - the cost to banks to borrow the money from the FRED, banks add their own profit margin on top - say 1 or 2%.
Due to the low rates this year, the number of refinanced loans doubled, tripled, even quadrupled in some areas and lenders became overwhelmed with refinance requests. The banks needed to slow things down, and when FRED dropped their rates even further, banks did not.
They were not incentivized to give even lower rates because they couldn't handle the extra business - you can read more here. Until now. Now they have the capacity to process more refinance requests, and rates are lower because - they want your business!
How to Get the Best Refinance Rate
You may know that not every homeowner gets offered the very best mortgage interest rates. How can you get the lowest possible interest rate for your refinance? On paper, you need to show evidence that you are reliable - that you always pay on time and can be trusted. This is reflected in your credit score.
Your credit score, according to Chase Bank, is made up of:
- Payment History (40%)
- Credit History (21%)
- Credit Usage (20%)
- Total Balances (11%)
- Credit Checks (5%)
- Available Credit (3%)
If you use credit and pay your bills, in full and on time, banks will feel confident they can trust you to pay off a 30-year mortgage. There are many tips and tricks that will help you over time, but for refinancing today, you will be rated on your credit score plus a few other factors. If you want the lowest interest rate, you want a credit score close to 800.
Other factors that will affect the refinance rate offered:
- Where is the real estate you are buying located? In particular rural vs. city.
- Size of the loan amount. A small loan won't make the lender as much money and attracts a higher interest rate. Similarly, a large loan is a greater risk for the lender to take on. For example, in the San Francisco Bay Area, many home loans have monthly loan payments of $10,000 or more. It would be very hard to make those payments if you were suddenly unemployed - hence higher risk equals higher interest rates.
- Home equity. When refinancing, this is a big help with lowering the interest rate because you've had your loan for a number of years and managed to pay off some principal. If your house value has also risen, you will have more equity. If you live in an area where house prices are falling, you should consider refinancing quickly while the valuation of your property and subsequent equity is above what you paid for the home. If your home valuation is lower than your current mortgage, you will not be able to refinance.
- Loan length. 15-year loan terms attract lower interest rates than 30-year loans. Again, the banks have a higher risk over longer terms. The type of loan you get will also factor - FHA, VA, Conventional, etc.
Bank or Broker? Who Should I Approach?
Your local bank gets its money from the FRED in the same way that a broker does. Both the bank and a broker act as agents of the FRED in getting money to home buyers or home refinancers. Both also stand to make a commission from working with you.
Banks tend to offer you their rate and their service only, and they may on-sell your mortgage to another bank. If you trust they can give you the best rate and best service, then they will be a good choice. A broker will be able to shop around for the best offer to suit your goal - either lower repayments or faster pay off.
Check out this great resource: The Loan Guide: How to Get the Best Possible Mortgage
Why You Shouldn't Refinance
The benefits of refinancing sound straightforward - paying less interest on your loan, lower monthly payments, or in the case of cash-out refinancing, getting money for needed home repairs, or credit card debt consolidation. But, refinancing may not be right for every homeowner.
When you refinance, you will need to factor in costs such as buying points and the cost of creating the new loan. Often referred to as Closing Costs, these can be between 2 - 5% of your new mortgage, although some lenders may offer to pay these for you as an incentive to do business with them.
For example, if you are 10 years into a 30-year mortgage term and you are contemplating a refinance to a 20-year loan for a lower interest rate, the closing costs may eat up any potential gain in savings with the new lower interest rates. If you can opt for a 15-year loan, you will see the savings if your loan is large enough.
A definitive way to calculate if refinancing is a good idea for you right now is the Mortgage Refinance Calculator at The Loan Guide.
Should You Refinance Your Mortgage Right Now?
The difference between 2.5 and 2.75% may not make a huge dent in your monthly mortgage payments but could add up over the life of the loan. Trying to time the market to be at an all-time low is likely just for bragging rights!
If you are ready to refinance, now could be a good time. The difference between what your current interest rate is and 2.4% should be large enough monthly savings to incentivize you to make that decision. Opt for a fixed-rate mortgage over an adjustable-rate mortgage when possible so you won't be surprised by your monthly payments when the interest rates rise again.
The biggest downside of refinancing a mortgage is really the paperwork required!. Since the financial crisis and mortgage fraud issues of 2007, lenders have tightened up the need for paperwork. Further, new legislation in some states has really increased the need for two years' proof of income and identification.
Use the refinance calculator to make the decision that is right for you - just be ready for that documentation!
You may also be interested in: Mortgage Refinancing Advice From 13 Finance Experts