As of September 16th, 2020, the Bankrate weekly mortgage rate survey has once again touched all-time lows with the average 30-year fixed rate mortgage sitting at 3.09% and the average 15-year fixed rate mortgage coming in at 2.53%.
For homeowners who have a mortgage, many have already taken advantage of falling interest rates by refinancing at some point over the last several years. For some it may be time to take advantage of falling rates again. While, there are usually closing costs associated with refinancing, if the reduction in your rate is material enough, those costs can be more than made up for by way of reduced interest costs over the course of a year or two.
My own general rule of thumb is that refinancing becomes a significant money saving event if one is able to reduce their rate of interest by one percent or more. A smaller rate reduction can also make sense for those who are planning on being in their home for many years to come.
As an example, consider a mortgage with a $300,000 balance outstanding for 30 years at a rate of 4.00%. This mortgage would have a principal and interest payment of $1,432 per month and some rough math suggests that in the current year, the amount of interest paid on the balance would be about $12,000 (4.00% x $300,000). If that same $300,000 were refinanced at a rate of 3.00%, the monthly principal and interest payment would fall by $167 per month to $1,265 and the amount of interest paid on the balance in the current year would be closer to $9,000 (3.00% x$300,000). This is a savings of $3,000 in just the first year. If the hypothetical closing costs for a refinance were $3,000, then this borrower would essentially be ahead of the game by the end of year one (interest savings in year 1 = cost to refinance).
What’s more eye opening is if both of the mortgages in the previous example are paid on schedule over 30 years. The total interest paid on the 4.00% mortgage would be $215,609, while the total interest paid on the 3.00% mortgage would be $155,332, which is a difference of more than $60,000 over the life of the loan.
This may also be a good time for someone who is a few years into a 30 year mortgage to consider refinancing into a 15 year mortgage. While a 15 year mortgage may have a higher payment, the lifetime savings in interest payments is enticing. As a follow on to the example above, $300,000 borrowed for 15 years at 2.50% would yield a higher monthly payment of $2,219 per month. However, the balance would be paid off in half the time, and the total amount of interest paid over the life of the loan would fall to $99,421.
One other consideration worth noting is that some financial institutions may offer an existing customer a lower rate without having to refinance. In most cases, this is only available on loans that the current bank owns and services.
While many would argue that the best mortgage is oftentimes the one with a $0 balance, for those who are not yet in a position to have their home paid off, now may be an ideal time to check your rate…again.
All comments and suggestions are welcome.
Christopher W. Frayne, CFA, CFP®