Although interest rates were low before COVID-19 sent our economy into a downturn, the Federal Reserve has slashed them to near-zero in response to the crisis. You may find that such low interest rates are an opportunity to save money by refinancing your mortgage.
Refinancing can be a good option to reduce the amount you pay in interest in the long run. It could even free up cash in the short term and give you financial flexibility, such as by doing a cash-out refinance that allows you to borrow more than your existing mortgage at a lower interest rate.
Why Is This a Good Time to Refinance?
Combined, these steps are generally lowering both short- and long-term rates, affecting the rates that financial institutions may charge you on everything from mortgages to credit cards to student loans.
How Does Refinancing Work?
Refinancing involves taking out a new loan to pay against another loan. Ideally, the new loan should have better terms for you. You can refinance with your existing lender or a new one, depending on the terms that you are offered.
For example, if you took out a 30-year mortgage at a 5% interest rate a couple of years ago, you might be able to refinance to a 30-year mortgage for 3.5%—the current average rate, according to Freddie Mac.
A new 30-year mortgage would extend the amount of time you would need to pay this debt; however, you may pay less in interest over time or help yourself now to cash flow flexibility in the form of lower monthly payments.
Alternatively, you could refinance your home with a shorter-term loan, such as a 15-year mortgage. You may end up with higher monthly payments, but refinancing to a lower interest rate could work out to your advantage.
You’ll want to consider factors such as how long you plan to stay in your home. If you want to move within a few years, then the costs and fees associated with refinancing may not make the new loan worth it. But if you have plans to stay for a while, then refinancing becomes more attractive.
Other Considerations for Refinancing
While many people can benefit from refinancing when interest rates are so low, not everyone will benefit the same—or at all.
If your credit score fell because you recently took out a loan, you might not receive helpful refinancing terms. (Conversely, refinancing could help you save your credit score if you’re unable to keep up with payments without adjusting your monthly expenses.)
To determine what’s right for you, consider factors such as the costs and fees associated with taking out a new loan or whether there’s a penalty for paying off your existing loan early. These costs can sometimes outweigh the benefits of receiving a lower interest rate.
You should also consider refinancing as part of your overall financial plan and long-range goals. If you are unsure how refinancing your debt is part of that picture, you may want to talk with a full-time fiduciary financial advisor who can help you determine the best course forward.
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This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.