If you bought a home while interest rates were higher, you may be able to cut back significantly on your monthly mortgage payment by obtaining a new mortgage with a lower rate.
The average 30-year fixed mortgage rate has been about 3.75% in recent months, according to the Federal Reserve1. The interest rate you qualify for may vary according to your credit rating. If your current mortgage is around 6% or higher, you may be able to gain significant savings by refinancing – particularly if you plan to stay in the home for many years to come. For example:
- Let’s say you have a 6.5% 30-year mortgage of $200,000. That would equal a monthly payment of about $1,315.
- If you could reduce that to a 3.75% rate, your monthly mortgage cost would drop to about $926 – a savings of nearly $400 a month.
However, there is one mitigating factor to keep in mind – closing costs, which are the fees you pay the financial institution to process the loan:
- Closing costs are typically in the range of 1 to 1.5% of the loan.
- For a $200,000 home, the average closing cost is about $2,128, according to Bankrate.2
- That means that if you can save $390 a month by going from 6.5% to 3.75% on a $200,000 mortgage, you could recoup your $2,128 in closing costs in the first six months. So even if you don’t know how many more years you’ll be in the home, refinancing would appear to be worthwhile in this case.
- At the other end of the spectrum, it may not be worthwhile to refinance for a rate reduction of 1% or less unless you are committed to being in your home for years to come. On a $200,000 mortgage, going from 4.75% to 3.75% would only save about $80 a month, so it would take more than two years to make up for the closing costs.
Another option to consider would be to take out a 15-year mortgage, which typically comes with a lower interest rate than the 30-year mortgages:
- The average 15-year rate was 3.22 % as of July 2019, according to the Federal Reserve3
- That was 0.53% lower than the 30-year rate.
While your monthly payment may not drop with a 15-year mortgage (in fact, it could increase), the shorter term will enable you to close out your mortgage faster while paying significantly less on interest payments.