- Rate-and-term refinance: This method earns property owners a better interest rate or improved loan terms, but for the mortgage balance. Think of it as an exchange of one loan for a more advantageous one.
- Cash-out refinance: Now let’s say you’re looking for access to cash—for instance, to remodel your home or address other expenses. For that, you’d look to an option called a cash-out loan, or home equity loan. Keep an eye out for additional fees and higher interest rates because the lender is exposed to more risk. (And you won’t be able to borrow unlimited money. Lenders usually restrict the maximum loan-to-value, or LTV, ratio.)
You might also want to refinance to a shorter term in order to pay off your home loan more quickly. Or perhaps you’re at the stage of homeownership where you have gotten enough equity in order to refinance into a loan without private mortgage insurance (PMI).
Other reasons to refinance might include pursuing that cash-out option, in which a homeowner could get access to cash from home equity to finance such major expenses as home improvements, college tuition, or investment property. This is especially tempting if your home value has dramatically increased.
Let’s look at historic mortgage rates throughout the last few decades for general context. Back before the financial crisis, the average 30-year fixed mortgage had an annual percentage rate of 6.48 percent, according to Investopedia. But after the crash, rates for the same kind of mortgage fell steadily—until the average was just 3.35 percent by the end of 2012.
From there, it started moving back up, and by the end of 2018, it sat at 4.54 percent, according to Freddie Mac’s chart that tracks the history since 1971.
Well, flash forward to the global coronavirus pandemic that slammed into the housing market—and the entire economy—beginning in early 2020. The Federal Reserve cut short-term interest rates to help boost the economy and lead to a shoring up of the mortgage financing system. The Fed’s two cuts in March of 2020 provide potential opportunities that triggered many homeowners to want to take advantage of the chance to refinance.
Refinancing at current rates could be a chance to replace an adjustable-rate mortgage with a low fixed-rate loan, access home equity with a cash-out-refinance, or eliminate FHA mortgage insurance.
But once you consider these costs along with the interest rate you could qualify for, you can calculate how your monthly payment might change. If there’s a measurable savings, you may want to go for it. Conventional thinking generally dictates it might be worth doing for a one percent savings or more—but you might find the specifics of your situation make it worthwhile even for a rate change less than that.
Beyond the fees and monthly payment, consider whether you have 20 percent equity or more in your home. If you have less equity, lenders typically require mortgage insurance to protect themselves in case you default, and that can be a pricey additional chunk to figure into your monthly payment.
Your own mortgage refinance rate is mainly based on both your home equity as well as your credit score. If that credit score is strong and you can demonstrate secure income, you have a better chance of getting a competitive rate and having the whole refinancing process make sense for your situation.
Note that plenty of factors outside your control—and outside your personal financial, credit, and employment picture—affect rates and the way they change over time. These include larger economic factors like inflation and job growth (not to mention a pandemic).
For instance, do you expect your lifestyle to change substantially in the coming months or years? Might you be growing your family, or will your family size shrink as adult children leave the nest? If you might be selling and moving to a different home before you break even on the associated costs, you won’t have saved any money through the process of refinancing.
If you’ve already paid off a big chunk of your home’s principal over a lot of years, refinancing also might be something to avoid: Refinancing into a new 20- or 30-year fixed-rate mortgage could cost you a lot in additional interest, even if you manage to reduce your rate significantly. In other words, try not to add too many years to your loan, because you’ll end up wiping out any interest rate savings by paying over a longer term.
In short, there’s a lot of context to consider apart from just the refinance rates alone when you consider whether refinancing is right for you.