Should I refinance my mortgage? Here's how to decide. | Explainomics

Mortgage rates plunged over the summer. In the last couple of weeks, even as they ticked higher, they're still significantly lower than a year ago. For buyers, lower rates make it a little more affordable to purchase a home. For homeowners who bought at higher rates, it might be a good time to refinance your current mortgage and lower your monthly payments significantly. The Federal Reserve in September kicked off a cycle of interest rate reductions. The mortgage market always tries to predict what the Fed is going to do next, so mortgage rates dropped ahead of the Fed's rate cut news. With the Fed expected to cut more, rates are expected to drop even further over the next year. But many homeowners are already racing to refinance. By mid-October, refinance activity was up more than 100% compared to the same period a year ago. Here's one way to think about the savings when you refinance. Let's say you took on a $200,000 mortgage at an interest rate of 6%. Your monthly payment is around $1,200 over the life of the loan. If you refinance that mortgage to a rate of 5%, your monthly payment drops by over $100. Multiply that over 12 months or over 30 years. That's a lot in savings. So should you refinance? Here's what to consider. In general, refinancing can make sense when the new rate would be at least 1 percentage point lower, although 2 points is better. That's because refinancing comes at a cost. Refinancing makes sense when you are lowering your rate enough to save money and also factoring the extra costs and fees. Let's look at an example. If you borrowed $200,000 to buy a house at a rate of about 8% and refinance it to about 6.5%, you'll be saving about $51,000 in total interest. That sounds good, but there's more to consider. First, you'll have loan fees, which can range from 2% to 5% of your loan balance, depending on where you live and the amount being refinanced. With a fee of 3.5%, your closing costs will be almost $7,000, which means it would take 3 years for you to break even on refinancing. You could roll your closing costs into the principal of the loan, but that will cut your savings. Another consideration is how long you intend to stay in the home. In general, if it's less than 5 years, it might be best to avoid refinancing and save any money that would go toward closing costs to cover moving and the cost of selling the home. If you're already living in what you've decided is your forever home, you can be less concerned about the break-even point. Other reasons to refinance include taking out some of your equity as cash. This involves taking out a new mortgage for more than your current mortgage balance and keeping the remaining cash. Because mortgage rates are lower than other loans, this strategy can be used to finance home repairs and improvements or to consolidate other debts. With interest rates down and projected to drop even more, now could be the right time to sharpen your pencil and start crunching the numbers to see if refinancing makes sense for you.