More than 1 in 5 Americans have a mortgage rate over 6%, which is greater than the share of the country with a rate under 3%. Average 30-year mortgage rates have now been over 6% (and as high as 7.91%) for nearly four years. If you are one of those with a rate over 6%, an opportunity to refinance your mortgage at a lower rate could save you a significant amount of money each month and provide some much-needed financial relief as inflation continues to run hot.
When will mortgage rates drop?
Mortgage rates are largely influenced by the federal funds rate. This rate, set by the Federal Reserve, determines what interest rates banks can offer for mortgages, car loans, unsecured debt, personal loans, and more. Mortgage rates will drop with the federal funds rate, which will be lowered as inflation declines, but the problem is inflation has stayed higher longer than many economists, and Fed officials, have imagined.
The recent Iran war has had a significant impact on fuel prices, which plays a major role in the rate of inflation. The good news is rising fuel costs can be reversed about as quickly as they spiked, so it will not necessarily have a long-term impact on the rate of inflation. Unfortunately for those hoping for lower interest rates, more Fed officials are now foreseeing interest rate hikes in the near future.
While interest rates could see hikes in the short-term, there are many reasons to believe interest rates could drop within the next few years. Job growth in the US is slowing, and rate cuts are often used as a lever to boost the economy. Many believe the effect of fuel prices and the Iran war’s impact on inflation won’t last long. But as we’ve seen over the last several years, the future of interest rates and inflation is very difficult to predict. We can’t know for certain where interest rates will be next year, much less five years from now, but it’s important to know exactly when you should consider refinancing your mortgage so you are ready when the time comes.
Should I refinance?
Refinancing a mortgage isn’t quite as simple as refinancing other debts because there are a significant amount of refinancing costs that need to be considered, along with how long you have left on your mortgage and how much longer you will remain in the home. You’ll typically pay between 3% to 6% of your refinance amount in closing costs. This means if you are refinancing a loan balance of $500,000, you’ll likely pay between $15,000 to $30,000 just to refinance.
To determine when it makes sense for you to refinance, you need to first determine your breakeven point. This is the point at which you have saved more on interest than you paid in closing costs to refinance.
I’ll use myself as an example. We bought a home in 2024 with a 6.5% interest rate, and our remaining balance is about $350,000. If we were able to refinance at 5.5% and pay 3% of the new loan amount in closing costs, we would break even after 47 months or about four years.
If mortgage rates dropped significantly and we were able to refinance at a rate of 3%, we would save a whopping $737 per month and break even after just 15 months. If rates declined ever so slightly to 6.25%, we would only save $57 per month and break even after 184 months or 15 years. If we planned to stay in the home longer than 15 years that could be a money-saving decision, but we will likely have a better refinancing opportunity in the future.
Right now, it probably doesn’t make sense for most people to refinance unless you can get a rate 1% or more below your current interest rate. While you may be able to save money over the long-term with just a small drop in interest rates, it is worth potentially waiting for better opportunities if you have a longer breakeven period. If you will break even after 10 years, for example, consider the odds that you would be able to refinance to a lower rate within those 10 years. If the odds are good, which they likely are, it is better to wait for a lower rate.
If your breakeven window is between two to five years, you have a tougher decision to make. Rates very well may drop more in the next five years, but they could just as easily increase. Keep in mind that nobody knows for certain what rates will look like in the future. If you told someone four and a half years ago that their 4.5% rate, which seemed high at the time, would seem like a bargain in 2026, I’m not sure if they would believe you.
If your breakeven window is less than two years, refinancing is almost a no-brainer as long as you will be staying in the home long enough to break even. A window this short means you will be saving a significant amount of money on your mortgage payment and could save well into the six figures on interest by refinancing.
Mortgage rates remain elevated and haven’t really budged over the past four years despite many experts predicting otherwise. Unfortunately, many Americans bought homes that exceeded their budget, banking on an opportunity to refinance at a much lower rate that hasn’t yet come to fruition. This should serve as a lesson to all future homeowners: if you are buying a home, assume you will be locked-in to your interest rate for the life of the loan. If you can’t afford the home at current interest rates, then you can’t afford it.
