Lower interest rates are finally here. Here's how to decide if you should refinance your mortgage.

Andrew Keshner and Aarthi Swaminathan

There's been upswing in mortgage refinances as rates have dropped. But the time may not be right for you.

A home may be forever, but a mortgage rate doesn't have to be.

With the Federal Reserve aggressively cutting its benchmark interest rate by 50 basis points on Wednesday, homeowners whose mortgage rates are at 6% and 7% may start considering refinancing in order to cut their monthly payments.

Refinancing a mortgage can be a good move, but it's not a simple one, financial advisers say.

Spotting a good-looking refi is a science that compares rates and closing costs. But it's also an art that weighs personal questions like attachment to a home.

So while it may soon become a good time for one person to refinance their mortgage, it could be a bad time for someone else.

There are already indications that more homeowners are refinancing. In the second week of September, refinancing activity jumped 161% from the same period a year ago, according to Fannie Mae's refinance index as of Sept. 13. That sounds like a big pop, but it's a jump from a lull when rate cuts seemed far off.

The average 30-year mortgage rate fell to 6.07% as of Sept. 16, according to the financial-services company Intercontinental Exchange (ICE).

Roughly 4.2 million borrowers were "in the money," or in a position to save considerably if they refinanced their mortgage, said Intercontinental Exchange. These borrowers could save at least 75 basis points through a refinance.

'The fog may finally be clearing on the refinance market.'Andy Walden, ICE vice president of research and analysis.

"The fog may finally be clearing on the refinance market," Andy Walden at ICE said in a statement, "with opportunity beginning to emerge for folks who purchased in recent years with the hope, or even expectation, that they would be able to refinance and improve their payments when the Fed let off the brakes on their rate policy."

Read more: Here's when falling interest rates will hit your mortgage, car loan, credit-card bills and savings accounts

But it's best to proceed carefully. "Just be cautious," said Gerald Grant III, a Washington, D.C.-based financial planner with Equitable Advisors. Mortgage rates will probably be about the same or lower in the near future, he said, so mortgage borrowers should give it some time in order to lock in the best rate.

"Because once you do it, once you pay those closing costs, you're not going to do it again," Grant told MarketWatch. "You're going to be kicking yourself if rates continue to fall a little bit more in the future, and you could have gotten a better rate down the road. Just take your time."

When does a mortgage refinance make sense?

When are rates low enough to justify refinancing your mortgage? One rule of thumb is that there should be at least a 75-basis-point difference between a homeowner's current rate and what they can get with a refinance, said Dann Ryan, managing partner at Sincerus Advisory. One basis point is one hundredth of a percentage point.

Getting a full percentage point, or 100 basis points, off a rate is even better, Ryan said.

Sure enough, the average rate on a 30-year fixed loan fell to 6.2% as of Sept. 12, Freddie Mac (FMCC) said. That's nearly a full percentage point lower than the rate of 7.18% one year ago.

The Fed doesn't set mortgage rates. Mortgage lenders tend to follow the yield on the 10-year Treasury note BX:TMUBMUSD10Y, but the central bank's federal-funds rate helps set the stage for other rates.

But homeowners shouldn't count on mortgage rates falling to 2% and 3% like they did at the start of the pandemic, which unleashed a refinancing bonanza.

Mortgage rates at 3% were an "anomaly," Fannie Mae's (FNMA) chief economist Doug Duncan told MarketWatch in June. Based on historical averages between 1950 and 2000, today's mortgage rates of roughly 6% are closer to normal than the rates during the pandemic were, he said.

A lower rate isn't the only factor to consider with a mortgage refinance

People who refinanced mortgages early this month took out loans for more than $337,000 on average, according to the Mortgage Bankers Association. But that doesn't include the array of fees and taxes required to complete a refinance.

Closing costs can range from 2% to 6% of a loan, and the median closing costs were almost $6,000 in 2022, according to the Consumer Financial Protection Bureau.

Read more: 3 ways the Fed interest-rate cut could jump-start buying and selling homes again

These costs can be paid up front or lumped into the monthly payment. But folding them into the monthly payment means a refinancer will pay more, because the costs are subject to interest, just like the loan's principal is.

And while closing costs might be negotiable, advisers say they can turn a refi into a bad move, depending on whether a person plans to move or stay in their house.

For example, Grant passed on a 2020 chance to refinance a Miami condominium to a 2.8% rate from 4.3% and shave $100 off his monthly payment. Grant said he wouldn't have been in the condo long enough to recoup what he would have paid in closing costs through his future savings on interest.

On the other hand, Grant refinanced his Maryland home, going to a 2.6% rate from 2.9%, because the lender waived closing costs. "It was a no-brainer. I did it right away because I immediately saved," he said.

"You really need to take into account whatever the amount of the closing cost is, and how long it's going to take you to break even," he said.

The same thinking applies to buying discount points in order to lower the rate on an existing mortgage, said Ryan. Discount points refer to money that a borrower pays up front to lower their mortgage rate by a certain number of basis points so their monthly payment drops.

The question is whether someone is going to stay in the home long enough to break even on the fees paid up front, he said. There's also the question of whether refinancing can get someone to a better rate than paying to shave off points, he added.

"We do hear of a lot of people buying down points. I just haven't seen that work a lot," Ryan said.

So you're thinking about refinancing your mortgage. Now what?

The first Fed cut in four years is fresh news. Ahead of the announcement, there wasn't even a clear market consensus about the size of the cut. Now the central bank is forecasting plans to shave another 50 basis points off its benchmark rate before the end of the year. Though there's no guarantee that will happen.

At a Wednesday press conference after the Fed's announcement, Fed Chair Jerome Powell was asked where mortgage rates go from here. "Very hard for me to say," Powell replied. For him, he said, the big question was how the economy developed from here.

In Wednesday projections, Fed officials estimated the economy would hold up as its benchmark rate eased. "If things work out according to that forecast, other rates in the economy will come down as well," Powell said. But the pace of any other rate decreases by the Fed will hinge on the economy's performance, he added.

For homeowners considering a refinance, some patience will pay off, Grant said.

"Maybe waiting around til January could be a good idea to see how things stabilize," he said.

As potential refinancers think about how long they plan to stay in their current home, Ryan said it's also useful to figure out how much interest they've paid already on the original mortgage, to determine whether the remaining interest from the first loan exceeds the price of interest and closing costs in a potential refinance.

Ryan said he helped many clients as they bought homes recently with mortgage rates in the high 6% and 7% neighborhood. He told them he couldn't predict where rates would go next. "The only thing I can guarantee you is you're going to refinance your rate at some point," he said he would tell them.

And that point could be coming soon. "It's definitely on the horizon," he said.

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-Andrew Keshner -Aarthi Swaminathan

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09-18-24 1719ET

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