Lower rates don’t always equal big savings on a refi — here’s what to consider before making your move.
If you purchased your home in the last year and a half or so, you may be considering whether you can save money by refinancing your mortgage loan now that rates have dropped a bit. After all, we are looking at the lowest rate we’ve seen in over a year following the Fed’s decision to cut rates by 50 basis points — or 0.5% — at its September meeting.
While that might mean savings for some, it’s not necessarily a blanket truth for everyone. Here are some practical considerations as you navigate a possible mortgage refinance and whether it makes sense for your financial situation.
1. How long do you plan to stay in your home?
Refinancing saves you money only if you get past the “break-even” point. The break-even point is when you’ve made back what you spent in closing costs and fees to refinance and are now tucking away monthly savings on your mortgage payment compared to before your refi.
So, if you’re staying less than a few years, you need to carefully weigh how much you’re saving each month compared to what it’ll cost you to refinance your home. Even with a lower monthly payment, if you move before you hit your break-even point, you’ve likely lost money on your refinance closing costs.
There are some caveats. If you don’t plan to stay too long, you can look into a no-closing-cost refinance. With this type of refinance, you’ll pay a somewhat higher rate, and in exchange, your lender covers part of or all the closing costs. This approach can make sense if rates have dropped significantly enough that even after accepting a rate hike on your no-closing-cost refinance, it is still lower than your previous rate.
However, you save a lot more monthly and over the long term if you can pay your own closing costs.
2. How big is the rate drop compared to your previous rate?
The general consensus is that a rate drop of .75% to 1%+ or more is a good time to consider a refinance. A rate drop of at least 1% likely means that you can recover the closing costs on your refinance fairly quickly — and see monthly savings.
But, how quickly you’ll see savings depends on your closing costs, how big of a rate drop you stand to gain and the size of your loan.
For example, let’s say your loan balance is $450,000. Your previous rate was 6.5%, and your new rate is 5.5%, with 2% in closing costs ($9,000). You’re looking at a monthly savings of $289, and your break-even point is 32 months, a little over 2.5 years.
Now, let’s say your rate drop is only .5% on the same loan. You’ll still see savings of $146 monthly, but after considering closing costs, your break-even point is 62 months — that’s a little over 5 years.
3. The size of your loan matters
The bigger the loan, the more you stand to save. If your mortgage is less than $250K, you’ll need at least a 1% rate drop to see significant savings.
Here’s an example. The illustration assumes 2% in closing costs.
| Loan amount | $200K | $200K | $400K | $500K | $600K |
| Old rate | 6.5% | 6.5% | 6.5% | 6.5% | 6.5% |
| New rate | 6.0% (Half percent rate drop) | 5.5% (1% rate drop) | 5.5% (1% rate drop) | 5.5% (1% rate drop) | 5.5% (1% rate drop) |
| Monthly savings | $65 | $129 | $257 | $321 | $386 |
| Break-even point | 62 months | 32 months | 32 months | 32 months | 32 months |
4. Has your credit score changed?
Just as it does with your purchase mortgage rate, credit score has a huge impact on the rate you’ll get when you refinance. If your credit score has gone up since you originally purchased your home, you’re in a good position to land a better rate, especially when paired with better market conditions.
However, if your credit score has dropped since purchasing your home, consider waiting until you can get your score up to par. Most refinance lenders want to see a score of 620 or above, but some lenders still work with borrowers with lower scores.
5. Shop around for your refi
When you’re ready to refinance your mortgage, you aren’t tied to your original lender. Sure, there are pros to sticking with your current lender, like a quicker or easier process. But there are possible cons, too.
Consider that your original lender knows your current interest rate and may only offer you a slightly lower rate instead of the lowest possible rate for your situation. Plus, you may still have to go through the entire underwriting process again, regardless of being a current customer.
Any way you spin it, it’s best to get mortgage refinance quotes from your current lender as well as multiple other top mortgage refinance lenders to make sure you’re getting the best rates and terms possible.
