May 24, 2023
When might interest rates start to go low enough to refinance?
An interest rate is the cost of borrowing money and compensates lenders for bearing the risk of lending money. Many factors determine the specific interest rate for your home loan, like credit risk, term, taxes, and economic cycles. Here are simple ways to predict mortgage interest rate fluctuation to secure a refinance.
What causes interest rates to fluctuate?
Most homeowners opt for a refinance when mortgage interest rates drop. However, it is relevant to consider that national monetary policy, the current economic cycle, and market competition can cause interest rates to increase and decrease. Here’s a list of some of the most common market predictors that preface a rate shift.
- The Government
The United States Federal Reserve (the Fed) frequently announces how monetary policy will affect interest rates. The federal funds rate, or the rate institutions charge each other to borrow money, affects the interest rate banks set on the money they lend, ultimately influencing the interest rate on your home loan.
- Economic Recession
A recession is when the national economy experiences negative growth and a slowdown in demand for goods and services. The Fed usually lowers interest rates during a recession to stimulate the economy by incentivizing purchase transactions.
- Supply and Demand
As supply and demand fluctuate, so do interest rates. As demand increases for money or credit, interest rates rise, while a decrease in demand for money or credit causes interest rates to drop. Similarly, an increase in credit supply reduces interest rates, while a decrease in credit supply increases rates.
Inflation also affects the price of interest rates. The higher the inflation rate rises, the more interest rates rise to keep up with the cost of living. If inflation decreases, mortgage rates drop and typically stabilize.
Mortgage interest rates exhibit seasonality as home buying demand usually decreases during winter months. January and February typically bring some of the lowest mortgage financing rates as lenders encourage purchase transactions.
Factors to consider when refinancing
A refinance replaces the terms and guidelines of the existing loan with a new loan and typically saves money over the life of the loan. Because interest rates are cyclical, many homeowners refinance when rates drop. If you refinance when interest rates decline, you might receive substantial savings. To leverage a refinance, consider the length of time you plan to live in the home and the cost of obtaining a new mortgage compared to the after-tax monthly savings. Here are three factors to consider when opting for a refinance.
1. Your new interest rate should be at least 1 to 2 percentage points lower than your current rate.
No matter what rates are doing, check that the math works out in your favor. Financial advisors agree a refinance is advantageous if the new rate is 1% to 2% below your current rate. However, neglecting to factor in your current loan term is detrimental. If you paid off five years on a 30-year mortgage and refinance to a new 30-year mortgage, it will now take 35 years to pay the mortgage, canceling any positive returns.
2. Don’t add more than five years to the length of your loan. Check to see if you can reduce.
You'll want to refinance into a shorter term if you are several years into paying off a 30-year mortgage. If you stretch out your payments for several more years, the money saved from a low-interest rate is lost. Depending on the years already paid off, it might be better to consider refinancing into a 25, 20, or 15-year mortgage to pay the mortgage faster at the low-interest rate.
3. You should be able to recover your closing costs in five years or less.
When applying for a refinance, closing costs will be required on the new loan. Crunch the numbers to calculate when you will break even on these fees before you move or sell the house to receive the most savings.
When deciding whether or not to opt for a refinance, it is crucial to understand the many factors that make interest rates rise and fall. This is the difference between cashing in on big savings or spending more over the life of the loan. Ask your loan originator to discuss the terms and guidelines on your current loan to help you get the most out of a refinance.