Elevated mortgage rates are making it difficult for homeowners looking to refinance to a rate lower than the one on their existing mortgage.
Refinance rates rose substantially last year as inflation skyrocketed and the Federal Reserve began hiking interest rates in an effort to rein it in. This year, refinance rates have eased slightly, but they’re still nowhere near the record lows of 2020 and 2021.
If you’re eager to refinance, it could make sense to do so now -- but that all depends on your old and new interest rates, and what you plan to do with the cash.
What to know first
The big story behind the mortgage market has been inflation and the Federal Reserve’s ongoing battle to tame it. Since March 2022, the Fed has raised its benchmark federal funds rate, from near zero to a range of between 5.25% and 5.50%, with the most recent hike on July 26. Depending on the state of the economy, the central bank initiates rate hikes and cuts to either rein in or encourage consumer spending and borrowing.
The steady increase in mortgage rates has been influenced by several factors, including the Fed’s rate hikes and inflationary pressures.
If the year-over-year inflation rate continues to inch closer to 2% -- the Fed’s rough target -- and the central bank is able to hold rates steady and eventually cut them, mortgage rates may see some relief. But if future inflation data is higher than expected, mortgage rates will likely increase in response.
When mortgage rates were at historical lows around the pandemic, many homeowners refinanced to get lower rates. But last year’s run-up in mortgage rates led to a drop in refinancing activity, and homeowners who would’ve sought cash-out refinances have instead tapped into their home equity for cash, turning to home equity loans and home equity lines of credit.
“In the current market with elevated rates, we see people doing refinances for very specific reasons, including needing to tap into the equity of the home, taking someone off of a mortgage or because their adjustable rate mortgage has expired,” said Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage.
While mortgage rates could fall closer to 6% by the end of the year, the days of rates in the 2% and 3% range are in the past and not in the near future. Unless you purchased a house within the past year, it’s unlikely you can save money by refinancing to a mortgage with a lower rate.
What is refinancing?
When you refinance your mortgage, you pay off your existing mortgage with a new home loan that comes with new rates and terms. If you secured your existing mortgage when interest rates were higher than they are today, refinancing at a lower rate can save you money on your monthly payment or allow you to pay off the loan faster (and sometimes both).
Reasons to consider refinancing
There are many good reasons to refinance when conditions are right. Some of the most common scenarios include:
- Reducing your monthly payments: Switching to a new loan with a lower interest rate or longer repayment term can reduce your monthly mortgage payment. The amount you’ll save each month depends on the size of your mortgage and how much lower the new interest rate is compared to your previous loan. Most experts recommend refinancing if you can reduce your interest rate by 0.75%.
- Paying off your mortgage sooner: If your original mortgage was a 30-year loan, you could refinance to pay it off sooner. With a lower interest rate, you may be able to switch to a 15-year loan and still have a manageable monthly payment. Reducing the length of the mortgage also lowers the total amount of interest you’ll pay over the life of the loan.
- Getting cash out of your home: With a cash-out refinance, you apply for a new loan that’s larger than what you owe on your old loan -- and take the difference as a cash payment. Many homeowners use a cash-out refinance to pay for home improvements.
- Switching to a fixed-rate loan: If you have an adjustable-rate mortgage, switching to a fixed-rate loan could be a good move. Refinancing can help you reduce future risk, according to Jason Fink, a professor of finance at James Madison University in Harrisonburg, Virginia. Locking in a fixed rate provides both predictability and protection from future rate increases.
- Switching lenders: If you don’t like your current lender, refinancing is one way of moving your business.
- Eliminating private mortgage insurance: Most loans require private mortgage insurance if you put less than 20% down when buying a home. As home prices have increased, you may have crossed the 20% equity threshold, creating an opportunity for you to refinance without PMI. (Note that you can also ask your current lender to eliminate the PMI without refinancing.)
Reasons to not refinance
- The fees are too high: While refinancing can save money in the long run, you’ll need to pay upfront closing costs that can add up to thousands of dollars.
- Interest rates are higher: If the interest rates have increased and your repayment term is the same, your payments will increase and you won’t save money.
- You’re planning on moving soon: It could take a few years to recoup your refinance fees. If you expect to move in a few years, the trouble and expense of refinancing now might not make sense.
- You’re nearly finished paying off your mortgage: Mortgages are designed so that your highest interest payments come during the early years. The longer you’ve had the mortgage, the more your monthly payment goes to paying off the principal. If you refinance later in the loan term, you’ll revert to primarily paying interest instead of building equity.
Different types of refinancing
There are a few different flavors of refinancing. Here’s a breakdown of some of the different ways to replace your current home loan:
- Rate-and-term refinance: A rate-and-term refinance replaces your mortgage with a new rate and/or term with one of two goals: save money or pay off the loan faster. For example, you might decide to refinance a 30-year mortgage with a 7.5% interest rate with a new 30-year mortgage with a 6.5% interest rate to reduce your interest charges. Or you might have 20 years left on a 30-year mortgage and opt to refinance to a 15-year mortgage -- ideally with a lower interest rate -- to accelerate your payoff timeline.
- Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new loan that has a larger amount. The goal with a cash-out refinance is to tap into your home equity and borrow cash at a low rate to cover a major expense such as remodeling your kitchen or paying for college.
- FHA or VA streamline refinance: If you have a mortgage backed by the FHA or the VA, you may be able to qualify for a streamline refinance. This “streamlines” the process by eliminating some of the additional paperwork involved. VA streamline refinances are commonly known as a VA IRRRL, or Interest Rate Reduction Refinance Loan.
How to get the best refi rate
Getting the lowest refinance rate available is similar to getting the lowest rate possible on a new purchase loan: It starts with your personal finances. Evaluate your credit report at least 30 days before you apply for a refinance; and if there is any incorrect information, dispute it. Creditors have 30 days to confirm the accuracy of the information or remove it from your report. Removing inaccurate information can improve your credit score and possibly help you qualify for a lower interest rate.
Taking steps to improve your credit, including paying off credit cards, can lower the risk associated with your new loan. It’s also important to compare options from multiple lenders. In addition to scoring the lowest rate, shopping around can help you find options with lower fees to help save on your closing costs.
Current mortgage and refinance rates
| Product | Interest rate | APR |
|---|---|---|
| 30-year fixed-rate | 7.59% | 7.61% |
| 30-year fixed-rate FHA | 6.74% | 7.67% |
| 30-year fixed-rate VA | 7.01% | 7.13% |
| 30-year fixed-rate jumbo | 7.62% | 7.63% |
| 20-year fixed-rate | 7.63% | 7.65% |
| 15-year fixed-rate | 6.82% | 6.86% |
| 15-year fixed-rate jumbo | 6.81% | 6.83% |
| 5/1 ARM | 6.51% | 8.14% |
| 5/1 ARM jumbo | 6.62% | 8.09% |
| 7/1 ARM | 6.74% | 8.17% |
| 7/1 ARM jumbo | 6.91% | 8.10% |
| 10/1 ARM | 6.79% | 8.12% |
| 30-year fixed-rate refinance | 7.78% | 7.80% |
| 30-year fixed-rate FHA refinance | 6.78% | 7.72% |
| 30-year fixed-rate VA refinance | 6.93% | 7.14% |
| 30-year fixed-rate jumbo refinance | 7.87% | 7.88% |
| 20-year fixed-rate refinance | 7.77% | 7.80% |
| 15-year fixed-rate refinance | 6.90% | 6.93% |
| 15-year fixed-rate jumbo refinance | 6.90% | 6.92% |
| 5/1 ARM refinance | 6.54% | 7.99% |
| 5/1 ARM jumbo refinance | 6.74% | 7.81% |
| 7/1 ARM refinance | 6.75% | 8.13% |
| 7/1 ARM jumbo refinance | 6.93% | 8.07% |
| 10/1 ARM refinance | 6.77% | 8.11% |
How to apply to refinance my home loan
If the conditions are right for refinancing, here’s a rundown of how to find the best deal.
1. Get your credit in great shape: While conventional lenders will approve refinance applications with a credit score of 620 or higher, the best rates go to borrowers with scores of 740 or higher.
2. Figure out how much home equity you have: How much is your house worth? And how much money do you still owe on your current mortgage? The difference is your home equity. Simply put, the higher equity, the better you’ll look in the eyes of a lender.
3. Compare multiple offers: You don’t have to refinance your mortgage with your current lender -- though it’s worth starting with them to see what they can offer. Some lenders will waive certain fees for current borrowers who want to refinance. Make sure you compare other options, though. Comparison-shopping is the key to saving money, whether you’re shopping for groceries or a new mortgage.
4. Lock your rate: Rates have been rising due to the Federal Reserve’s work to fight inflation, so it’s important to lock in a rate once you find one that suits your needs. If you don’t, you could wind up paying more. Make sure you ask about a float-down rate lock, which lets you take advantage of lower interest rates if they become available.
5. Communicate: Once you settle on a lender, it’s important to be responsive to requests for financial documentation. The faster you respond, the faster you’ll be able to close on the new loan, and the faster you’ll be able to start saving money with your lower rate.
FAQs
There may be a slight difference between average refinance rates and average rates for purchase loans. The bigger difference between buying a new home and refinancing your current mortgage tends to be with the closing costs. The closing costs for refinances are lower, averaging less than 1% of the total loan amount. There are some exceptions, however, in New York, Pennsylvania and Delaware, where closing costs are significantly higher.
Refinancing involves paying closing costs, though the costs tend to be lower than with a new purchase loan. In 2021, the average closing costs to refinance a mortgage for a single-family home added up to $2,375, according to data from ClosingCorp. That figure does not include any local taxes, however, which can add thousands in certain parts of the country.
To figure out if refinancing makes financial sense, you need to determine your break-even point: When your savings are greater than the costs associated with refinancing the loan. This ultimately comes down to how long you plan to live in the home. If you’re going to pay $6,000 to refinance your mortgage for a lower rate, for example, you’ll need to determine if you will be in the home long enough for the savings you’ll receive each month to add up to more than $6,000.
