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Refinancing may seem tempting now that interest rates are falling. But it’s a common misconception that lower rates automatically make refinancing cheaper, according to Realtor.com senior economist Jake Krimmel.
Krimmel cautioned that it may not make financial sense for many homeowners, especially those looking to move soon.
Refinancing is considered a smart move if it adopts a rule called the “breakeven point,” which considers whether the initial cost is offset by the savings from a lower rate. In today’s market, many homeowners would not pass this test.
“The size of the loan, the remaining term and, most importantly, how long the borrower plans to live in their home all matter,” Krimmel said, adding that “a rule of thumb is to divide closing costs by monthly savings.”
Although the Federal Reserve has cut interest rates for the third time in a row, that doesn’t necessarily mean mortgage rates will fall. Interest rates are not directly affected by the Fed’s interest rate decision, but closely follow the yield on ten-year government bonds.
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Although policymakers have indicated that there could be only one rate cut in the new year as rates move closer to neutral levels, economists expect mortgage rates to fall slightly and hover around 6.3% next year.
While this drop isn’t huge, just lower than the 6.6% average in 2025, it raises questions about refinancing, Krimmel said.
On July 2, 2024, a “for sale” sign is seen outside a house on a canal in Cape Coral, Florida. (Photo by OCTAVIO JONES/AFP via Getty Images/Getty Images)
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Refinancing isn’t free – homeowners still have to pay closing costs on the new loan. That’s why it’s important that the savings from lower monthly payments outweigh those costs over time, Krimmel said.
On July 31, 2019, newly constructed single-family homes are listed for sale in Encinitas, California. (Reuters/Mike Blake)
Refinancing only makes sense if the new mortgage interest rate is about 0.5 to 1 percentage point lower than what a homeowner already has, because according to Krimmel it provides enough savings to justify the costs of refinancing.
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Today, most homeowners have mortgage rates well below current market rates, so they would lose money if they refinanced. This is what is commonly known as the ‘lock-in’ effect. Today, for example, only those with mortgage rates of 6.65% or higher would reach the breakeven point at which refinancing could pay off. Currently, more than 80% of homeowners have mortgage rates below 6%, meaning only a small group of borrowers could benefit from refinancing anytime soon.
A sign is placed in front of a home for sale in San Rafael, California on August 7, 2024. According to a report from Zillow, 30-year fixed mortgage rates fell 31 basis points to 6.06%, while 30-year refinance rates fell 1.15% to 6.06%. (Justin Sullivan/Getty Images)
So if someone plans to move soon, Krimmel said refinancing “probably” won’t be worth it.
The people who would benefit most are those who recently – within the last two to three years – bought homes when interest rates were between 7% and 8%. Even a small drop in market interest rates could leave them more than 1% in the money, making refinancing attractive. But these borrowers also typically have large loan amounts and plan to live in their homes for at least five more years, so refinancing savings would be more important.
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Meanwhile, any small interest rate drops are “fairly irrelevant” to homeowners who are “out of money” or stuck with low mortgages of 3% to 4%.
Homeowners should also remember that it’s not just about the reported average mortgage rate, but also the rate they can secure. Credit, down payments and shopping are extremely important and may outweigh fluctuations in Fed policy, according to Krimmel.
