Does it take less of a rate drop to refinance now?

Posted by  on Jan 25, 2013

Q: As mortgage rates get lower, does it take less of a drop in rates to justify refinancing? It seems like it might, because every percent drop now is a bigger deal than when mortgage rates were at ten percent.

A: That's an interesting perspective. If rates at 10 percent dropped by half of one percent, the decline would be just 5 percent of the original interest rate. If rates today, at around 3.5 percent, dropped by the same amount, the decline would represent 14 percent of the original interest rate. So, in that sense, a half-percent drop today is a bigger deal than it was when rates are higher.

Still, the primary hurdle when refinancing is the amount of closing costs involved, which isn't really a function of the level of interest rates. This points out why mortgage calculators are a much more valuable tool for making refinancing decisions than any rule of thumb about how much interest rates have to fall before you refinance.

After all, there are always a number of variables involved in refinancing - the interest rates before and after, the closing costs, but also factors such as how long you have remaining on your current loan compared to what the term on a new loan would be. If you've taken enough years off of a current 30-year mortgage, you might want to consider refinancing with a 15-year mortgage, to take advantage of the added drop in rates that comes with a shorter loan. In the end, it takes a refinancing calculator, rather than a one-size-fits-all decision rule, to account for all these variables and scenarios.

In one sense, though, your comment about rate drops meaning more now than in the past still has merit. You still need to make sure that a mortgage calculator shows you'll come out ahead before refinancing, but you may want to act on smaller advantages knowing that future drops in mortgage rates will be harder to come by.

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