Meet Judy, a dedicated banker and a single mom of two energetic girls. In July 2023, she decided it was time to stop dealing with her landlord’s issues and pursue her dream of homeownership. After searching through house listings in Winnipeg, Judy found the perfect home for her and her daughters. With enough savings for a down payment, she felt ready to take the leap and secure a mortgage.
Unfortunately, Judy didn’t realize that interest rates were at their peak at the time, hovering around 8%. With excitement overshadowing caution, she took out a $400,000 mortgage on a 30-year term, without fully considering the long-term impact of those high interest payments.
As the months passed, the weight of her decision began to take a toll. The high interest rates made budgeting a significant challenge, leaving her feeling stretched thin each month.
Recently, Judy learned that the Bank of Canada (BoC) had reduced the key interest rate to 3.75%. This news sparked a glimmer of hope for her. With the possibility of refinancing her mortgage to secure a lower rate, she began to explore how this change could help alleviate some of her financial stress. As a single mom, every dollar counts, and Judy is eager to find options that could save her money in the long run.
Should she refinance her current mortgage for a lesser interest rate now that rates are low? Or should she wait a little longer for rates to drop further? What are the factors she has to consider carefully before she decides?
I recently spoke with a seasoned mortgage loan consultant, and he shared his perspectives on when to refinance, when to hold off and what considerations you should weigh. I will be discussing all of these in details in this blog post. Without skipping a beat, let’s get into it.
Should I Refinance My Mortgage Now That Rates Are Falling?
Well, the answer to this question isn’t straightforward, it depends on your individual circumstances because several key factors play a role in determining whether refinancing is a beneficial move for you.
1. The Initial Interest Rate
First, you must consider your initial interest rate vs the current interest rate. If your current mortgage rate is significantly higher than the new market rates, refinancing can be a savvy financial move. It could lead to lower monthly payments and a reduction in the overall interest paid throughout the loan term.
The general rule of thumb is a 0.75% to 1% rate reduction for refinancing to be worthwhile. This reduction typically covers the closing costs and other associated expenses, allowing you to start saving money sooner. If you can secure a new mortgage rate that falls within this range compared to your current rate, it’s likely a beneficial decision.
For example, if Judy took out a $400,000 mortgage in July 2023 on a 30-year fixed term with an interest rate of 5.25%. With this rate, her monthly payment would be about $2,208. Over the life of the loan, the total interest would amount to $394,880.
With the BoC’s recent rate cut, let’s say she can now refinance at a new interest rate of 4.75% for the same 30-year period. Under this new rate, her monthly payment would be approximately $2,087 and a total interest amounting to $351,320.
With this refinance, she would save around $121 per month. Over the loan’s life, this equates to a total savings of approximately $43,560 in interest payments.
2. Closing Costs and Fees
Next, consider the closing cost, prepayment penalties, discharge and legal fees incurred when you choose to refinance your mortgage.
Refinancing incurs closing costs which typically range between 2% and 5% of the loan amount. Your closing costs might include application fees, loan origination fees, appraisal costs, title search and insurance fees.
Sometimes these costs are rolled into the loan, but that adds to your principal and, ultimately, your interest payments. Confirm all potential costs before committing, as they can impact your breakeven point and the overall savings.
The breakeven point is the time required to recoup your refinancing costs from the monthly savings. For example, if your closing costs are $4,500 and refinancing saves you $121 per month, it would take roughly 37 months (or a little over three years) to break even.
If you’re planning to move sooner, refinancing may not provide the savings you’re looking for. But if you intend to stay more than 3 years, refinancing your mortgage will be a good idea.
Should I Hold Off a Little Before Refinancing My Mortgage?
Well, deciding whether to hold off on refinancing your mortgage is not that simple. There are a few key factors you must consider before deciding.
Due to the frequency of the announcements by the BoC, there is a possibility that interest rates may continue to drop, but they could also rise again if economic conditions change.
Many financial analysts suggest that, while rates have recently decreased, it’s wise to consider the long-term potential of further cuts. Holding off right now could lead to even better rates, but it’s a gamble since rates are influenced by various economic factors, including inflation and central bank policies.
Also, refinancing incurs closing costs, which usually range from 2-5% of the loan amount. If you refinance now, and the rates drop again, you might be tempted to refinance again, incurring more closing costs.
These repeated costs could erode your savings, even if the monthly payments seem lower. You should consider calculating how long it will take to recoup those fees with your reduced payments.
Here’s what I would say, if the current rates offer significant savings over your current rate and you plan to stay in your home long enough to recoup the closing costs, you should probably consider refinancing now.
However, there is speculation that we may see further rate cuts in the coming months. So it might be best to hold off a little longer. Holding off for a bit could offer even more savings.
It is best that you consult a mortgage advisor to analyze the numbers specific to your loan and financial situation.
What Should I Consider Before Refinancing My Mortgage?
With interest rates on a downward trend, refinancing your mortgage can be an attractive option to lower your monthly payments or reduce the overall cost of your loan. However, it’s crucial to weigh several factors before making a decision:
1. Current interest rate vs new rate
Look at the difference between your current mortgage rate and the new rates being offered. Generally, a drop of around 0.75% to 1% is a good rule of thumb for refinancing to be worthwhile, as it offsets closing costs and leads to monthly savings. If your current rate is significantly higher, refinancing could be beneficial.
2. Closing costs
Refinancing comes with fees, typically ranging from 2% to 5% of your loan amount. These include application, appraisal, and title fees. Some lenders may offer “no-closing-cost” options by slightly increasing the interest rate, so consider if these fees balance with the potential savings.
3. Prepayment penalties and other fees
These are usually separate from closing costs and are paid directly to your lender if you break your existing mortgage before the term ends. They won’t generally appear in the “closing costs” section of your refinancing statement, though they are often due at the time of refinancing.
If you switch lenders, the existing lender also charges a discharge fee to release your mortgage, so carefully consider these fees before deciding to refinance.
4. Break-Even Point
The break-even point is when the savings from your lower monthly payments cover the refinancing costs. For instance, if the closing costs for your current mortgage is $4,000 and you get to save $200 per month, it would take 20 months to break even. If you plan to stay in your home beyond this period, refinancing could be worthwhile.
5. Loan size and remaining term
Larger loans benefit more from refinancing with even small rate reductions, while smaller loans may need a greater rate drop to offset costs. Additionally, if you’re well into your loan term, refinancing to a new 30-year term might reset your amortization, costing you more in interest. Alternatively, you could refinance into a shorter term, like 15 years, to save on interest over time.
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- Neo Mortgage Review (2024): Pros, Cons & Features
Final Thoughts on Refinancing Your Mortgage
Refinancing can be a valuable way to lower your mortgage payments or take advantage of new, lower interest rates, but it’s not a one-size-fits-all solution. Consider the interest rate difference, potential prepayment penalties, closing costs, and how long you plan to stay in your home.
The savings should outweigh the costs for it to be worthwhile. Timing, current rates, and your personal financial goals are key to making the best decision.
Whatever you decide, ensure it aligns with your long-term financial plan so that refinancing truly serves as a step forward. If you’re ready, a consultation with your lender can provide clarity on whether now is the right moment to refinance.
