Mortgage rates are at a record low—here are 3 questions to ask before you refinance
Mortgage rates hit a record low on Friday, March 6, when the average rate on a 30-year fixed mortgage hit 3.29%, according to Freddie Mac. The previous low was 3.31% in November 2012, on the heels of the financial crisis.
For nearly 13 million of borrowers — the highest number of candidates on record — refinancing could lower their current rates by 75 basis points, which could amount to thousands in savings over the life of the mortgage.
However, before you start shopping around for the best rates, it's crucial to remember that refinancing isn't free. In some cases, it could take a decade or more to recoup the upfront costs.
If you're considering refinancing your home, your first step should be to figure out if it will actually save you money. Here are three questions to ask yourself before you refinance.
1. Will you earn your investment back?
In order to secure a lower interest rate, you have to pay closing costs again, which can include bank fees, appraisal fees and attorney fees, among other things.
These costs typically run between 1% and 2% of your total mortgage balance, although that can vary, John Cooper, a certified financial planner at Greenwood Capital, tells CNBC Make It. On a $300,000 mortgage, for example, you would expect to pay around $6,000 in fees.
Once you've done the math to figure out how much it would cost to refinance, you need to figure out how long it would take you to earn that money back. "It's best to recoup the closing costs in five years or less," Cooper says. "You don't want to extend it too long, or else you're not really making a lot of headway."
Say you took out a $400,000 30-year mortgage 10 years ago with a 4.5% interest rate and have already paid down $80,000 of your balance. For the next 20 years, you can expect to pay around $2,026 per month on the rest of the $320,000 mortgage, Cooper calculates.
If you're able to refinance with a 3.75% interest rate on a 20-year mortgage, your monthly payment would drop to $1,897, saving you around $130 per month. That means it would take you just under four years to recoup the $6,000 it cost to refinance. Cooper says that's generally a good deal.
You should also think about how long you plan to stay in your home. "If you won't be in the house long enough to recoup the cost and time, it is not worth it," Kristin Baker, chief of staff at White Oaks Wealth Advisors, tells CNBC Make It. "Have your lender run a break-even analysis so you know exactly when the savings outweigh the costs and make sure you plan to be in the home that long."
Generally, "the longer you plan to spend in a house, the more worthwhile a refinance could be," Sean M. Pearson, a certified financial planner at Ameriprise Financial in Conshohocken, Pennsylvania, tells CNBC Make It.
2. How seasoned is your loan?
Refinancing doesn't make sense if you're losing your potential savings to additional interest costs. "If you are five years into a 30-year mortgage and you refinance into another 30-year mortgage, you are going back to the beginning and may pay more in total interest," Baker says.
However, that doesn't necessarily mean that you should refinance into a shorter term mortgage. "If a borrower isn't too far into the loan term they may still end up paying less in interest if the rate is reduced enough," Baker says. "Furthermore, most people don't stay in their homes for a full 30 years; often the full effect of the interest over the whole term isn't realized."
Scott Frank, a certified financial planner and founder of Stone Steps Financial, agrees that you shouldn't automatically jump into a shorter term mortgage. They often come with higher monthly payments, and "most people are looking to refinance because it will reduce their monthly payment which will allow them to put those funds to work in another area of their life," Frank tells CNBC Make It.
"If someone wants to pay off a loan faster, I prefer they get a 30-year fixed rate loan and pay it as though it is a 15-year loan," Frank adds. On a deeply seasoned loan, refinancing might result in the borrower owing a significant amount in interest. But if you're saving enough each month that you can increase your monthly principal payments to pay off the loan faster, you might be able to avoid the additional interest, he explains.
3. What are your other financial goals?
You don't want to spend the time, effort and money it takes to refinance just to lose those savings to lifestyle inflation. Think through exactly how you plan to use your newfound savings.
It's important to look at all financial decisions from the bigger lens of what matters most to you in life. What are you aiming for?Scott Frankcertified financial planner
"It's important to look at all financial decisions from the wider lens of what matters most to you in life. What are you aiming for?" Frank says. "And then anytime you can optimize cash flow, you need to always be thinking about, 'Where can I put this to help with me with a better life?'"
It's smart to check in on your other priorities. "When you are considering a change to your monthly bills, it's a good time to take a moment and consider your progress on other goals, such as saving for education, retirement or a wedding," Pearson says.
While refinancing could be a way to save money in the long-term, it's not worth it if the upfront costs put you in a financial hole. "Ask yourself if you have three to six months' worth of savings in the bank to cover things like a job loss, unexpected home repair or next year's vacation before you consider paying additional fees today," Pearson adds.
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