Mortgage rates are at record lows. Is now the time to refinance?

Mortgage rates have never been lower. While that can present a great opportunity to refinance, does it mean you should?

The average 30-year fixed-rate mortgage fell below 3% for the first time ever last week, according to Freddie Mac. The 15-year fixed-rate mortgage dropped to 2.48%.

And homeowners are taking notice.

Refinance activity surged higher, with requests for refinances making up 64% of total mortgage applications the first full week of July, according to the Mortgage Banker's Association.

As a rule of thumb, refinancing your mortgage is worth it if the new rate is roughly 1% lower than your current rate. But there are plenty of other factors -- including closing costs, your loan term and how long you plan to stay in your home -- that you need to consider.

What will the new rate be?

Rates have been falling for months as the economy continues to struggle from the effects of the coronavirus pandemic. The new sub-3% average rate for 30-year mortgages is the seventh record low since March -- and no one knows how much further rates might fall or when they may rise again.

"Even those of us in the mortgage industry were surprised when rates fell below 3%," said Ron Svoboda, a mortgage loan officer at Lincoln Federal Savings Bank in Nebraska.

Last week he locked in 30-year fixed-rate mortgages for clients at rates ranging from 2.625% to 2.75%. He also saw a highly qualified borrower lock in a 2.125% rate on a 15-year fixed-rate mortgage for $200,000.

"With Covid-19, the election, the economy, everything that we're hearing is that rates are not going up anytime soon," Svoboda said. "But I don't know how much lower they can go down."

The majority of mortgage experts expect rates to stay the same or even drop further next week, according to a poll from Bankrate.com. But the market is volatile and at some point, rates could be driven higher, said Vishal Garg, chief executive and founder of Better.com, a digital lender.

"By waiting, you potentially risk missing out on benefiting from today's historically low rates," he said.

The high demand means that refinances can take weeks to close.

Svoboda said the process can typically take about five to six weeks. He said people who locked in rates weeks ago -- but hadn't closed yet -- are now asking to lock in again at the lower rates.

What are the costs?

A big reason people refinance is to reduce their monthly payments, but don't overlook the full cost of the loan.

"Who can't use lower debt in a time of uncertainty?" said Jason Prattes, a financial adviser at Sprive Capital Management. "But the focus in this environment should be on the cost structure."

The cost is typically around 2% to 3% of the loan amount, with the origination usually costing about 1% alone, but even that can vary among banks, online lenders and brokers. Shop around to compare loan costs from lenders, not just the rates.

Other fees include processing and underwriting, appraisal, title and application and recording fees. The results of your appraisal -- if your home has gone up or down in value -- could change the terms and cost of your loan.

Also, keep in mind: even though a loan is advertised as a "no cost" loan, it doesn't necessarily mean it costs less. While the lender won't directly charge costs upfront, the loan will likely carry a higher interest rate than other options that come with closing costs.

What is the loan term?

The length of the loan will determine how much total interest you pay on your mortgage. If you have lived in your home for five to 10 years and plan to stay for a good many more, refinancing again into a 30-year loan may cost you more.

"While your monthly payment may go down, refinancing back to a 30-year loan may end up costing you more interest because you're essentially starting over," said Ryan Mohr, a certified financial planner with Clarity Capital Management in Oregon.

In that case, look at refinancing to a 20- or 25-year term, and weigh the total amount of principal and interest over the life of your existing loan against a new loan before finishing a refinance, he said.

When will you break even?

While you may consider refinancing if you can get a rate that's 1% lower than your current rate, the real deciding factor is how long it will take to recover the cost of refinancing, said Jennifer de Thomas, a certified financial planner with Birch Elliott Financial.

"The lower the total cost of the refinance, the better the deal," she said.

It is important to understand your breakeven point, or the point at which your savings in monthly payments and interest overcomes the added costs of refinancing. If it takes you longer to get to that point than you plan to stay in the home, then refinancing may not be a good plan.

For example, take a $300,000 loan at a rate of 4%, with a monthly payment of $1,400. If you refinance at 2.5%, your monthly payment is now a more affordable $1,200.

"But if that loan cost $10,000, it will take four years to recover the cost through the lower payment," she said. "If you plan on staying in the house, no problem. But if you sell the house next year, the amount you owe is closer to $310,000. Not a great deal."

The back of the envelope calculation is to take your total costs (including closing costs, title, appraisal and other fees) and divide by your monthly savings, said Mohr. That will tell you how many months you need to be in the home to break even on the cost of refinance. But there are plenty of mortgage refinance calculators to help you figure this out, too.

Other reasons to refinance?

Refinancing also gives you the opportunity to shorten the life of your loan.

When Sean Weaver, a certified financial planner in Southlake, Texas, did a cash-out refinance on his home in 2018 to do some remodeling, he got a 4.5% rate on a 30-year fixed-rate mortgage.

Now he is refinancing his 30-year mortgage to a 15-year loan. While he expects his monthly payment will increase by $350, he's cutting 13 years off the life of the mortgage and saving tens of thousands of dollars in interest payments.

"For many folks adding $350 a month, [or] $4,000 a year, to their mortgage payment isn't doable," he said. "But I can do it and it's worth it to me. I'm 43 now and I can pay my house off before I'm 60."

Some people also look to refinance so they can eliminate a private mortgage insurance payment, said Svoboda.

Buyers in the past few years who didn't have a large amount of cash to put down would have had to pay PMI, he said. "If they have been in that house for three to four years, by refinancing they can get out from under that PMI."

The rates are here, the deciding factor is whether it benefits you, said Garg.

"Don't try to time the market," he said. "If the numbers make sense to help you achieve your financial goals, that's when it makes most sense to refinance."