Should You Refinance Your Mortgage While Rates Are Low?

The mortgage industry (and interest rates) have a somewhat complicated relationship with the rest of the overall economy. Generally speaking, when the economy is doing very well, the Federal Reserve will start raising interest rates. This can help to try and ward off inflation which is not great for the economy. Conversely, when overall economic conditions are poor, the Federal Reserve will LOWER the interest rates, in an attempt to spur economic growth. Since the interest rates on most mortgage products are (directly or indirectly) tied to the overall Federal Reserve interest rate, these actions have a pretty significant impact on mortgage interest rates.

Mortgage rates can fluctuate daily or even hourly, so it’s good to have a basic idea of what you want to do and what might make you want to refinance. With mortgage rates at historic lows, let’s take a look at what that means and whether you should refinance while rates are low.

Mortgage rates are at historic lows

The mortgage market is a fairly complicated market with several different types of mortgages available. So when you hear that mortgage rates are at “historic lows”, it’s important to understand what type of mortgage is being talked about. Usually, the 30-year fixed mortgage is the loan product that is considered the “standard” mortgage. So if you hear about rates “dropping”, you’re usually hearing about the 30-year fixed. It is true that usually (but not always!) rates for different types of products rise and fall together.

(SEE ALSO: What is a “Good” interest rate?)

It was not uncommon in the 1970s or 1980s to see mortgage rates with double-digit interest rates. Since that time, interest rates have generally steadily dropped, to a low around 3.5% in 2012. Mortgage rates fluctuated in the 3-4% range for the next several years before rising to around 4.5% in 2018 and 2019. 

The recent coronavirus pandemic has affected the housing market and sent rates on the 30-year fixed mortgage down under 3.5%, around the lowest those rates have ever been.

Should you refinance to a 30-year mortgage?

As the name implies, a 30-year fixed mortgage will lock in your interest rate for the duration of your loan. You’ll have 360 monthly payments, all of the same amount. The exact amount you pay will depend on the amount of your loan, the duration and the interest rate. You can use our Loan Repayment calculator to find out the exact amount of your monthly payment. Keep in mind that that monthly payment amount will not include your property taxes or home insurance. Your lender may require that you set up an escrow account, or else you’ll need to make sure to budget for those expenses on top of your monthly mortgage payment.

The 30-year fixed mortgage will usually give you your lowest monthly payment. In fact, even if you currently have a 30 year fixed mortgage, you will likely save on your monthly payment by refinancing now. That is because of 2 reasons – the rates are likely lower than when you first got your mortgage and because you’ve paid down your mortgage balance so the amount you’re refinancing is less. 

Should you refinance to a 15 or 20-year mortgage?

Another option to consider when refinancing is to refinance to a 15 or 20-year mortgage. A mortgage with a shorter term (like 15 or 20 years) will usually have a lower interest rate than the 30-year fixed mortgage. However, because the shorter term means there are fewer payments, your payment may still go up.

If you’re currently on a 30-year mortgage, you’ll likely (but not always) find that the monthly payments on a 15 or 20-year mortgage will be higher. The good news is that your mortgage will be paid off 10 or 15 years sooner! Overall you’ll pay quite a bit less in interest.

An example of refinancing to a shorter-term mortgage

To illustrate the types of choices you have with refinance, let’s look at an example. Our fictional homeowner bought her house 5 years ago with a mortgage of $250,000, and took out a 30 year fixed mortgage. Her monthly principal and interest payments have been $1,267 per month, and after 60 payments, her mortgage balance is now $228,305.36 with 25 years remaining.

She’s looking to refinance with today’s low rates. We’ll say that her closing costs will make her new loan payoff amount $230,000. Again using our Loan Repayment Calculator, here are some options she could consider:

• A 30 year fixed loan at 3.5% – monthly payments would be $1,033. 
• A 20 year fixed loan at 3% – monthly payments would be $1,276.
• A 15 year fixed loan at 3% – monthly payments would be $1,588.

You can see that refinancing to another 30-year mortgage would drop her payments by $234 each month. That comes at a cost of adding 30 more years to the total time it takes to repay. With a 20 year loan, her payments only go up $9 per month but she shaves 5 years and tens of thousands of dollars of interest over the course of the loan. A 15-year loan would pay even less interest but at a cost of increasing the mortgage payment by $321 each month.

Of course, every situation is different but hopefully, this can serve as a guideline to help you as you make your own decisions about refinancing.

The case against refinancing

Even though mortgage rates are at historic lows, refinancing is not right for everyone. Here are a few cases where it might not make sense to refinance, even if today’s interest rates are lower than the rate on your current mortgage:

• You’re not sure if you’ll be in your home long term. Refinancing does come with some upfront costs, and if you won’t be in your home long enough to pay them back, it might not make sense
• Your credit score or financial situation has taken a recent hit
• You want to take advantage of some of your home’s equity with a home equity line of credit.
• You don’t have enough money to pay the upfront closing and other costs associated with a refinance. If this is the case, see if it might make sense to roll those costs into your new loan.

For even more information about the pros and cons of refinancing, check out our list of 8 refinancing tips