Mortgage Rates Just Plunged. Is It Time to Refinance?

The average 30-year mortgage rate plunged to 6.47% last week -- its lowest level since mid-2023. The short explanation is that recent economic data has been weaker than expected, and this increases the possibility that the Federal Reserve will start lowering benchmark interest rates.

In any event, this is significantly lower than the average mortgage rate of just a week prior and is sharply below the 7.79% peak we saw last fall. This raises the question -- at what point is it worth refinancing your mortgage?

The mathematics of refinancing

Don't worry -- I'm not going to turn this into too much of a math lesson. But as a homeowner with a mortgage, it's an important concept to be able to evaluate the costs and benefits of refinancing.

We'll start with the costs. Refinancing isn't free. Just like when you get a mortgage to purchase a home, there are closing costs associated with refinancing. These can vary significantly, but generally run between 1% and 2% of the loan amount. So, for a $400,000 refinancing loan, $5,000 in closing costs would be reasonable to expect.

Next is the benefits. Using a mortgage calculator, figure out the difference a lower rate would make in your monthly payment. If you're currently paying $2,500 per month, and refinancing would lower your payment to $2,200, your monthly savings would be $300.

The short version (told you I wouldn't get too math-heavy) is that if you plan to stay in your home long enough so the monthly savings will significantly outweigh the costs of refinancing, it could be a smart idea.

To be perfectly clear, this isn't an exact science. Most people don't know with 100% certainty how long they plan to stay in their homes, and life can get in the way of staying as long as you hope to. It's also worth noting that I'm focusing this discussion on people who bought homes at the elevated mortgage rates of the past couple of years, and therefore still have 28 or 29 years remaining on their term. If you have a mortgage you've been paying down for longer, you also need to consider the additional repayment time involved with obtaining a new 30-year loan.

But the point is to weigh the costs against the savings using the best information available to you at the time.

An example of when refinancing makes sense

To illustrate this, let's say that you bought a home a year ago and got a 30-year loan for $400,000 with a 7.25% mortgage rate. This would give you a monthly principal and interest payment of $2,729. Since you bought it a year ago, you'll have also paid down about $4,000 of your principal, so to keep the numbers simple, we'll say that you still owe $396,000.

You apply to refinance, and a lender offers you a loan with a 6.375% interest rate with $6,000 in closing costs. This would make your monthly mortgage payment drop to $2,471 per month, a savings of $258. So, dividing $6,000 in closing costs by this amount shows that you would break even after about 23 months.

Let's take a look at the long-term implications:

• If you kept your original mortgage, you would make 29 years of $2,729 payments, for a total of $949,692.
• If you refinance, you'll make 30 years of $2,471 payments, for a total of $889,560. Adding the $6,000 in closing costs would bring the total to $895,560.

In this case, even with the closing costs and an additional year in repayment, refinancing would save you about $54,000 over the term of the loan.

The bottom line

While it's important to evaluate refinancing on a case-by-case basis, generally speaking, if you bought a home in the past couple of years and you have a mortgage rate of 7% or higher, it could be worth at least looking into refinancing.

As a final thought, one of the most common follow-up questions I hear is "but what if rates go down even more?"

To be fair, they could, and if the Federal Reserve starts to aggressively cut rates later this year, that's exactly what I would expect to happen. If it does, there's absolutely no rule that says you can't refinance more than once -- in fact, I have a friend who refinanced their mortgage twice in 2021 alone as rates plunged.

If the numbers make sense, you're free to refinance again -- and either way, refinancing now could give you a more affordable housing payment in the meantime.