Should I refinance my mortgage?

With the Fed working to lower interest rates, mortgage rates may dip further.

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Key takeaways

  • A series of unusual events all coincided to push mortgage rates up after the Federal Reserve lowered the key benchmark rate on March 15.
  • Since then, the central bank has committed to buying as many Treasurys and mortgage-backed agency securities as necessary to provide the needed liquidity to the economy—which is working to push some mortgage rates down.
  • Lenders may still be working through high demand for refinances so rates may vary by lender. Shop around.
  • If you're thinking of refinancing your mortgage, consider the cost, your goals, and the number of years left on your current loan, among other things.

Mortgage rates did something unusual after the Fed's unprecedented weekend rate cut and quantitative easing announcement on March 15—they went up. The reason: a combination of high demand for refinancings along with selling in the mortgage-backed securities markets.

The good news for homeowners looking for a silver lining to the COVID-19 crisis: Mortgage rates on 30-year fixed-rate loans began to drop on March 23 after the Fed announced it will buy unlimited amounts of Treasurys and agency mortgage-backed securities.

Bond yields move inversely to price. With the central bank buying as much as necessary, the increased demand for mortgage-backed bonds should work to push interest rates on fixed-rate mortgages even lower.

What drives mortgage rates

While the fed funds rate is a key benchmark for many consumer loans like credit cards and car loans, it does not directly affect most conventional mortgages. Instead mortgage rates are generally tied to the 10-year Treasury yield.

The spread between the 10-year Treasury and mortgage rates is typically around 180 basis points but it reached more than 260 basis points in mid-March as demand for refinancings and selling pressures on holders of mortgage bonds mounted.1 A basis point is one-hundredth of a percent. By early April, interest rates on 30-year fixed-rate loans had fallen slightly, though the spread with Treasurys was still high due to the fact that the rate on the 10-year Treasury continued to fall.

If that trend continues, the question for homeowners may be, does it make sense to evaluate a mortgage refinance? If you’re asking that question, here are some steps to take.

Do your homework

Consider your goal first. Are you trying to lower your monthly payment or lower the total amount of interest you'll pay?

If you're 10 years into a 30-year loan, refinancing to another 30-year loan with a lower interest rate means you're back to square one, with 30 years of monthly payments ahead of you. Your monthly payment may be lower due to the lower interest rate—or longer payback period—but your overall interest costs will go up as the net effect would be adding 10 years to your loan.

In order to save money over the lifetime of the loan, you could consider refinancing into a 20-, 15-, or 10-year mortgage. Depending on the interest rate differential between your existing mortgage and currently available options, that may raise your monthly payment, but it could dramatically reduce the amount of interest you pay over the lifetime of the loan.

Check your credit score

No matter how low interest rates go, your credit score has a big impact on the interest rate you'll pay. Be sure to check your credit report for errors and ensure that your debt-to-income ratio is in a range that makes lenders comfortable.

Consider refi costs

The cost of a refinance can be significant—3%–6% of your outstanding principal, according to the Federal Reserve Board. It may take some calculations to see if a refinance would help you save money after the upfront cost. There are many online calculators that can help here.

Just like taking out an initial mortgage on a property, refinancing involves closing costs. They can include the cost of an appraisal, application fees, and even attorney fees. You may have options for paying some of these fees and expenses. Paying them up front can often be the least expensive option. If you can't afford to pay the closing costs up front, your lender may allow you to roll them into the loan. Though you won't pay money today, you'll end up paying interest on those fees and expenses over the life of the loan. Alternatively, your lender may also offer the option of a higher rate loan in exchange for no closing costs.

If you need private mortgage insurance, which is usually required if your equity is less than 20% of the value of your home, that can be another cost to consider.

Your taxes may be affected by refinancing as well. If you itemize, you may be accustomed to getting a deduction for the interest paid on your home loan. A change in the interest rate could change the amount of your deduction, which may be a consideration for tax planning. The degree to which your taxes could be affected depends on the number of years paid on the original loan and the new loan term.

If you have a loan for more than $750,000, up to $1 million, that was taken out before December 15, 2017, another consideration may be the limits established by the Tax Cuts and Jobs Act (TCJA). The TCJA limited the home mortgage interest deduction to interest paid on the first $750,000 of a mortgage. Refinancing more than that amount could lead to a smaller deduction if the original loan predates the new law.

When you refinance, interest initially becomes a larger portion of the payment relative to principal. That may end up increasing the amount of mortgage interest you're able to deduct—at least on the first $750,000 of your loan.

Understand ARMs

With an adjustable-rate mortgage (ARM), the interest rate is fixed for a predetermined number of years, and then it fluctuates, within limits, for the remaining term of the loan. An example is a 7/1 ARM. The 7 refers to the number of years before an adjustment can be made. After the seventh year, the loan may adjust every year. Rate changes are determined by a benchmark index plus a margin percentage set by the lender.

If you currently have an ARM and are concerned about rate resets in the future, it can make sense to refinance into a fixed-rate loan to take advantage of lower rates. Some of the considerations include when your current loan resets and how long you plan to live in the home.

What else should you know?

  • If you're planning to move in the next couple of years, refinancing doesn't make sense. To know when it does make sense, calculate your breakeven point. Start with the cost of refinancing and then divide it by the amount of money you'll be able to save each month by refinancing. That will give you a rough idea of how many months it will take for your refinance to pay off.
  • Be sure to check rates across a range of lenders. You can apply for a mortgage refinance with multiple providers as you shop around. Each lender is required to provide a loan estimate within 3 days of your application. The full approval process will require a more in-depth review of your finances. The good news is that credit scoring models generally allow about a month for multiple credit inquiries as you look for the best deal. Borrowers could save as much as $1,500 by shopping around according to research by Freddie Mac.2
  • Generally your mortgage payment combined with insurance payments and all other loan payments, such as car loans and college loans, shouldn't exceed 36% of your total income. This is known as your debt-to-income ratio and 36% is a rough guideline that many lenders use.3

Adjust your financial plan

Housing is typically the biggest item in a family's budget. If you are able to lower your monthly mortgage payment with a refinance, consider how you may be able to put those savings to work based on your goals and priorities.

Pay down your mortgage faster. Continue making your original mortgage payment to pay down the loan more quickly and save money on interest.

Save more for retirement. You may be able to speed up your retirement timeline by funneling the money saved on your mortgage into retirement savings.

Pay down other debts. Consider putting the extra cash in your budget into debt payments if you have any lingering balances—particularly those with high interest rates.

Increase your living expenses. If your retirement savings are on target, your emergency fund could cover at least 3 to 6 months' worth of essential expenses, and there's no debt to pay down, you may be able to increase your discretionary spending.

Next steps to consider

Call or visit to set up an appointment.

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