If you own a home and are eager to refinance to capitalize on lower interest rates, you’re certainly not alone. In mid-September, applications for a mortgage refi increased 127% compared to last year. That’s because the average rate for the benchmark 30-year fixed-rate mortgage loan dropped from a 2024 high of 7.22% in early May to as low as 6.08% in late September, according to the Federal Reserve Bank of St. Louis.
That represents a significant drop of 114 basis points. (Basis points are a key financial measurement used to represent changes in mortgage interest rates; one basis point equals 0.01%, so 100 basis points correspond to a 1% change.)
Is it worth refinancing a mortgage for 1%? How much does a 1% interest rate difference affect mortgage payments? What key factors should you consider besides the rate when determining whether to refinance? And when does a 1% drop make refinancing worth it?
For answers to these and other key questions, read on.
Key Takeaways
- Recent declines in mortgage rates make refinancing attractive, with the potential to reduce both monthly payments and total interest expenses.
- For example, refinancing a $400,000 mortgage from 7.32% to 6.32% could result in monthly savings of about $197 and a total interest reduction of $44,763.
- Borrowers of larger loan amounts stand to benefit even more from small rate cuts.
- Homeowners should assess refinancing costs, including closing fees, and calculate the breakeven period to decide if refinancing is worthwhile.
- Refinancing might not be advisable if you plan to sell soon, cannot afford closing costs, or anticipate further rate drops.
How Much Does 1% of Interest Impact Your Payments?
Thanks to recent interest rate drops, it’s an exciting time to ponder a mortgage refi. Although mortgage rates have crept up a bit recently, they’re still lower than their late-2023 highs.
So, if you refinance soon, you may be able to lower your mortgage rate by around 1 percentage point (100 basis points), which can significantly impact your monthly payment and the life of your home loan.
Example: Let’s say you bought a home a year ago that cost $400,000. You put $80,000 down (20%) on a 30-year fixed-rate mortgage loan at a 7.32% interest rate. That means your current monthly principal and interest payments are about $2,165. If you stick with this loan unchanged, you’ll pay $502,592 in total interest after 30 years.
However, if you refinance to a new 30-year fixed-rate mortgage loan at a 6.32% rate (1 percentage point, or 100 basis points, lower), your new monthly principal and interest payment would be roughly $1,968 – a monthly savings of nearly $197. Although you will reset your loan from scratch, thereby paying an extra year (30 years versus 29 years), you will actually save approximately $44,763 in total interest with this refi loan. That’s a substantial amount that could make refinancing well worth it for this example.
But imagine you could only lock in a new refi fixed rate of 6.82% (0.5 percentage points, or 50 basis points, lower). That means you’d pay about $2,073 every month, equating to a lower savings of only around $92 and a total interest savings of just under $7,083. Considering that you’ll have to pay closing costs (more on that shortly), refinancing in this scenario doesn’t make as much sense.
Key Factors
The mortgage interest rate you will pay is a crucial criterion to consider before committing to a refinance. But it’s not the only factor you should evaluate carefully. Let’s dig deeper into other matters that should play a major role in your decision.
Loan Size
The amount of money you need to borrow – called your principal – makes a big difference here.
“Larger loans benefit more from smaller rate changes because the overall savings are magnified,” says Dennis Shirshikov, an economics and finance professor at City University of New York/Queens College.
To demonstrate why, let’s say you bought a $600,000 home instead of a $400,000 home a year ago at the same fixed rate, 7.32%, and made a 20% down payment. Consequently, your monthly principal and interest payments would be just shy of $3,297, and your total interest paid over 30 years would tally $707,016. If you refi to a fresh 30-year loan at 6.32% fixed interest, you’d now pay $2,949 monthly, saving much more monthly and over the loan’s term: $348 and $85,751, respectively. That’s much more than the respective $197 and $44,763 you’d save if you bought that $400,000 home.
Loan Term
The length of time left to repay your loan is significant too.
“If you are extending the term, you might reduce your monthly payments but end up paying more in total interest over the life of the loan,” cautions Carl Holman, director of Communication and Content for A&D Mortgage.
For example, let’s go back to that earlier example of a $400,000 home purchase. You closed on the loan a year ago (at a 7.32% rate), but imagine you wait to refinance for another four years—in 2028. That means you would have paid off five years of your principal balance. In this situation, your outstanding principal balance would be $302,229 after 60 months of payments (5 years).
However, if you refi to a new 30-year fixed-rate loan at 6.32% four years from now, you’d shave over $323 off your monthly payments, but you’d pay more than $15,474 extra in total interest over the life of this loan because you’ve reset your mortgage and added five years of extra payments (30 years versus 25 years).
PMI
If you put down less than 20% on your home purchase, you are likely paying private mortgage insurance (PMI), often 0.5% to 1.5% or more of your loan amount. This is due monthly until you reach 20% equity.
But you can eliminate PMI earlier than scheduled by refinancing if your equity has increased since you closed on your original mortgage loan – which occurs by paying down your mortgage balance over time, making accelerated payments on your mortgage, and/or making home improvements. So, on top of capitalizing on a lower interest rate, you can save even more by refinancing and getting rid of your PMI payments.
Costs of Refinancing
Often, the make-or-break factor for many borrowers on the fence about a refinance is how much it will cost. You can likely expect to pay between 2% and 6% of your loan amount in closing costs.
“These expenses must be factored into whether the savings from a rate reduction will outweigh the upfront costs,” adds Holman.
Using the earlier example, where you refinance your existing loan with an outstanding principal balance of $316,945 (from that $400,000 home you bought one year earlier), your closing costs could be between roughly $6,000 and $19,000. Considering you’ll be saving about $44,763 in total interest by refinancing in this example, the costs to refinance could be worth it—assuming you plan to stay put and not move or sell your home anytime soon (more on this next).
Breaking Even on a Refinance
Indeed, those closing costs should play a huge role in your decision, and you can better decide if it’s worth the cost based on your “breakeven period.”
“The breakeven period is the time it takes for the savings from a mortgage refinance to match the cost incurred during refinancing,” notes Daniel Bauer, head of residential lending for Alliant Credit Union in Chicago. “To calculate your breakeven period, divide the total closing costs by the monthly savings.”
For instance, if your closing costs are $6,000 and your monthly savings amount to $200, your breakeven period would be 30 months.
“This metric is crucial for homeowners to consider, as it helps determine whether refinancing is worth it based on their plans to stay in the home. If you intend to move before reaching the breakeven point, you may not recoup the costs,” adds Bauer.
When a 1% Drop Makes Refinancing Worthwhile
Now that we’ve covered all the important refinance bases, let’s address two crucial questions: when does refinancing make sense, and is it worth refinancing a mortgage for 1%?
“Refinancing for a 1% rate reduction can be worth it, especially with larger loans or long-term plans to stay in your home,” Bauer suggests. “To assess if it’s worth it, crunch the numbers carefully and calculate your breakeven point.”
The general rule of thumb, lenders will tell you, “is that refinancing is usually worthwhile if you can reduce your rate by at least 1%,” agrees Holman.
Remember:
- A larger loan balance will benefit more from small rate changes if you refinance. In other words, you don’t need that big of a rate drop to take advantage of big savings monthly and over the life of your loan if you have a high outstanding principal balance.
- A longer breakeven point makes refinancing riskier, especially if you think you’ll sell your home anytime soon.
- Resetting to a new, longer term—such as 30 years after you’ve already paid down your principal balance for several years—can result in paying more in total interest after a refi.
When Refinancing for 1% Doesn’t Make Sense
If you plan to sell your home within the next few years, the savings may not outweigh the closing costs before you sell.
“For instance, if your breakeven period is five years, but you only plan to remain in the home for three years, refinancing wouldn’t make financial sense,” Holman cautions.
Refinancing for 1% may also not be wise if you:
- Can’t afford the closing costs (although these can be rolled into the loan via a higher principal borrowed or a slightly higher rate).
- Will pay significantly more in total interest over the life of the loan and expect to stay put.
- Anticipate rates to drop even further in the future.
Ready to Get Started?
Again, doing the math before committing to a refinance is essential. Calculate how much you’d save as well as your breakeven period, and talk with a trusted lending professional who can help you explore all your options and determine if refinancing is worth it.
