Interest Rate Cuts: Refinancing, Rates and What You Need to Know

As inflation begins to cool, Americans are patiently waiting for the Federal Reserve to make interest rate cuts. As of August 2024, the Fed has kept the key interest rate at an eye watering 5.3%, which has been a 23-year high. Talks of potential interest rate cuts have sparked excitement and anticipation among homeowners and home buyers. While lower rates present a great opportunity to save money on your mortgage through refinancing, it’s important to understand the factors involved in rate cuts and how this impacts you.

In this guide, we’ll break down key points that you should know to help you make an informed decision about whether refinancing is right for you when rates drop. 

What to Expect From the Fed Interest Rate Cuts

At this time, Americans are anxiously waiting for the Fed to make interest rate cuts after they stated it was “on the table” for their next interest rate announcement in September. The Fed has set a target inflation rate of 2% and once that’s achieved, they’re likely to lower interest rates. 

A note before we continue: at Defy, we cannot provide financial advice, so if you are looking for financial advice or insights regarding your finances to pay for a home loan, please consult your CPA, financial advisor or another related professional. Okay, let’s continue! 

Even small interest rate cuts can make a big difference in the overall cost of a home loan. Beyond this year, policymakers are anticipating a benchmark rate as low as 4.1% by the end of 2025. It’s possible that homeownership could become much more affordable later this year, and for the next few months or even years to come. 

Impact on Mortgage Interest Rates

Despite the Fed holding off on interest rate cuts, the impact of the anticipated change is already being felt in the financial markets. The first rate cut is almost entirely priced in, especially in the bond markets. As of August 2024, current 30-year fixed-rate mortgage rates have dropped to 6.47%, which is the lowest they’ve been in over a year. With the unemployment rate increasing to 4.3%, the Fed will likely need to accelerate their plans for cutting rates, potentially leading to further decreasing rates in the coming months. Although this is not confirmed, it’s important to consider.

Refinancing and Buying a Home

Refinancing activity has begun to gain traction as mortgage rates continue to decline. According to the Mortgage Bankers Association, refinance activity was up 27% in June 2024 compared to June 2023. Before refinancing your mortgage, consider factors like your monthly mortgage payment, remaining loan term, and the closing costs. 

Taking a look at buying a home with lower rates, this could make it a favorable time to buy for potential homeowners – lowering rates means lower rates. With lower borrowing costs, buyers can afford higher-priced homes or put more money toward a larger down payment. However, lower interest rates tend to stimulate the housing market, which leads to more competition among buyers.

Depending on the available inventory of the housing market, this could potentially make the home buying process more challenging – not to say it will, but again, something to consider. If you’re looking to buy a home soon, make sure you’re pre-approved, are ready to make a competitive offer, and are willing to act quickly when something you want is on the market. 

Should I Refinance When the Fed Makes Interest Rate Cuts?

Refinancing when the Fed makes interest rate cuts can be a smart financial move, but it depends on factors that are specific to your situation. If your current mortgage rate is much higher than the new rates, refinancing could lower your monthly payments and reduce the total interest paid over the life of the loan. 

While lower monthly payments may sound good, there are also costs to consider. You’ll most likely have to pay closing costs and fees, which could be worth it if you’re planning to stay in your home long enough to break even on these expenses. 

Ultimately, refinancing when rates are low can help many homeowners save money on their monthly payments and even unlock built-up equity. On top of that, you have the option to change your loan type to help you achieve your financial goals. 

For example, many people refinance to switch from an adjustable-rate mortgage to a fixed-rate mortgage to have payment stability. Refinancing doesn’t have to be complicated with Defy. Contact us for a free consultation and we can guide you through the process. 

How Much Homeowners Could Save by Refinancing

Homeowners who refinance when interest rates are cut can potentially save thousands over the lifetime of their mortgage. Even a seemingly small rate reduction of 0.25% can add up over the years. 

For example, reducing the interest rate from 6.5% to 6.25% on a $300,000 mortgage could save a homeowner approximately $15,000 in interest over a 30-year term. Larger rate reductions can lead to even bigger savings, lowering monthly payments and freeing up more cash. In anticipation of interest rate cuts, homeowners should closely follow the market and do their calculations to take advantage of potential savings. 

Smart Moves to Make When the Fed Cuts Rates

When the Fed makes interest rate cuts, it’s an ideal time to make some smart financial moves to maximize your savings and improve your overall finances. Again, while we can’t give financial advice, we’ve found some proactive steps you can take that we wanted to share with you:

• Improve Your Credit Score: A higher credit score can help you qualify for better mortgage rates, so take steps to pay down debt and correct any discrepancies on your credit report.
• Shop Around for the Best Lender: Different lenders offer different rates and terms, so compare multiple lenders to find the best deal.
• Consider Refinancing: Refinancing to a shorter-term loan or a lower interest rate can significantly reduce the amount of interest you pay over the life of your loan.
• Lock in Low Rates: If rates are favorable, consider locking in a low rate to protect against potential future increases.
• Evaluate Your Financial Goals: Align your mortgage decisions with your long-term financial goals, whether that’s reducing monthly payments or paying off your loan faster.

Taking these steps can help you take full advantage of interest rate cuts and put you in a better position for your financial future. Speak with your financial advisor about which, if any, financial steps could work for you.

Refinance Loan Options

One advantage to refinancing is having the opportunity to switch mortgage type, interest rate type, and loan term. If you originally secured your mortgage years or even decades ago, there’s a chance that it might not suit your current financial needs. Refinancing allows you to review all of your loan options and essentially secure a brand new mortgage that’s right for you. 

Next, we’ll cover some refinance loan options to consider.

Non-QM Loans

Non-QM loans (non-qualified mortgages) provide a flexible alternative for refinancing, especially for borrowers who don’t meet the strict criteria for traditional loans. Those who are self-employed or have fluctuating income can benefit from the less restrictive underwriting guidelines of non-QM loans. 

There are several loan types that fall under the non-QM loan umbrella, including: 

• Bank Statement Loans: Designed for self-employed borrowers who can verify their income using bank statements instead of traditional tax returns.
• P&L (Profit & Loss Statement) Loans: Allow self-employed individuals to qualify for a mortgage based on their profit & loss statements prepared by a CPA.
• DSCR (Debt-Service Coverage Ratio) Loans: Tailored for real estate investors, where the loan qualification is based on the property’s income rather than the borrower’s personal income.
• Asset Depletion Loans: Allow borrowers to qualify for a mortgage based on their liquid assets rather than traditional income.

Not sure which loan would work best for your refinance? Defy can help! Contact us and one of our mortgage experts can help you determine which loan option would be right for you. 

Conventional Loans

A conventional loan is the most common type of mortgage, making up 44.8% of all originated mortgages in Q4 of 2023. These loans offer lower rates for borrowers with good credit and stable income, which can lead to big savings over the life of the loan. On top of that, homeowners can eliminate private mortgage insurance (PMI) once they’ve built up at least 20% equity in the property. Despite being a popular choice for refinancing, their qualification criteria can be difficult to meet for borrowers whose incomes don’t fit the traditional mold. However, for borrowers that can qualify, conventional loans can be a cost-effective refinance solution. 

Government-Backed Loans

Government-backed loans offer some advantages for borrowers who can’t qualify for conventional loans. These loans were designed to make homeownership more accessible with lower down payment requirements, more lenient credit score requirements, and competitive rates. Below, we’ve outlined some of the most popular government-backed loan types to consider:

• FHA Loans: Ideal for those with lower credit scores.
• VA Loans: Offer favorable terms and no down payment for eligible veterans and active-duty service members. 
• USDA Loans: Cater to rural homeowners with moderate incomes, providing zero-down financing options. 

Refinancing with a government-backed loan can lower your interest rate and reduce your monthly payments, overall making homeownership more affordable and sustainable. 

At Defy, we offer all of these loan options for refinancing and more. We specialize in tailored loan solutions and aim to make home financing as accessible as possible for a wide variety of people. If you’re still unsure of which loan type you should choose, book a free consultation with us and our mortgage experts would be more than happy to help. 

Things to Consider Before Refinancing

Even though refinancing comes with multiple benefits, there are still certain factors to consider to make sure it aligns with your financial goals. Here are some key things to consider before refinancing:

• Mortgage Rates: Locking in a lower interest rate is important, but it shouldn’t be the only factor. Assess the overall market trends and forecasts to make an informed decision.
• Debt-to-Income Ratio: Lenders will evaluate your debt-to-income (DTI) ratio to determine your eligibility for refinancing. Typically, lenders accept a maximum DTI of 43%, but ideally prefer a DTI lower than 36%. 
• Loan Term: Decide whether to shorten or extend your loan term based on your financial goals. A shorter term can save on interest, while a longer term may reduce monthly payments.
• How Long You’ll Stay in the Property: Refinancing costs should be justified by the length of time you intend to stay in the home.
• Break-Even Point: Calculate the break-even point to determine how long it will take for your savings to cover the refinancing costs. If you’re staying in the home long enough to break even, refinancing could make sense for you. 
• Refinancing Costs: Account for closing costs, appraisal fees, and other expenses. These costs can impact the overall benefit of refinancing.
• Financial Situation and Goals: Evaluate your current financial situation and goals for the future. Refinancing should align with your long-term financial strategy.

Taking these factors into considerations can help you get a full picture of whether a refinance will benefit you, leading you to make an informed decision. 

What Should My Next Steps Be?

If you’re considering refinancing when rates drop, it’s a good idea to plan ahead. At this point, all signs are pointing toward interest rate cuts before the end of 2024. Taking these next steps can set you up for success when it’s time to refinance:

1. Stay Updated on Market Conditions: Keep an eye on market trends and anticipate rate changes by tracking the Federal Reserve’s interest rate announcement dates and other economic indicators.
2. Research Lenders and Loan Types: Starting your research early will put you in a good position to take advantage of the interest rate cut. Look into lenders you may want to work with and contact them to get an idea of their qualification requirements. Learn more about loan types and determine which one may suit you best. 
3. Calculate Potential Savings: Run the numbers on your potential savings to see if it’s worth refinancing. Rates are expected to drop even further throughout 2025, so you’ll likely save more with an even lower rate if you’re willing to wait. 
4. Talk with a Financial Advisor About Improving Your Credit Score: Your credit score is one of the most important personal factors that lenders consider when offering you an interest rate. While you’re waiting for rates to drop, work with a CPA or financial advisor on getting your credit score as high as possible to secure the most competitive rates. 
5. Work with a CPA or RIA to Evaluate Your Financial Situation: Carefully consider if refinancing aligns with both your current financial situation and long-term goals. Ask yourself whether the potential savings justify the refinancing costs and consult a financial professional before doing so. 
6. Consider Your Long-Term Plans: Refinancing is usually most beneficial for homeowners who plan to stay in their home for a longer period of time. Calculate your break-even point to see if refinancing will be worth it in the long-run.
7. Weigh Pros and Cons: Analyze both the pros and cons of refinancing for your situation. Take into account closing costs and other expenses against the amount you could save on interest and monthly payments. 

Preparing for your refinance ahead of time allows you to be prepared and act quickly as soon as we see interest rate cuts. Researching, running your numbers, speaking with financial advisors, and weighing pros and cons will leave you feeling even more confident in your decision to refinance. 

Interest Rate Cuts FAQs:

1. What is an interest rate cut?

An interest rate cut is a reduction in the interest rate set by a central bank, like the Federal Reserve, to make it cheaper to borrow and stimulate economic growth. 

2. How do interest rate cuts affect mortgage rates?

Interest rate cuts typically lead to lower mortgage rates, making it ultimately cheaper to own a home. 

3. Should I refinance my mortgage when interest rates are cut?

You should consider refinancing your mortgage when interest rates are cut since your monthly payments and the total interest will be reduced. However, it’s important to consider the costs of refinancing and whether you plan to stay in your home long enough to benefit from the lower rates. 

4. What are the benefits of refinancing during an interest rate cut?

There are several benefits of refinancing during an interest rate cut including:

• Reducing your monthly payments
• Paying less interest over the life of the loan
• Switching from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage for payment stability
• Potentially shortening your loan term
• Unlocking equity you’ve built up in your home 

5. Are there any downsides to refinancing when rates are cut?

Some downsides to refinancing when rates are cut include:

• Paying closing costs
• Extending the loan term can potentially increase the total amount of interest paid 
• Not reaching the break-even point if you don’t stay in your home long enough

6. How do I know if refinancing is right for me?

It always depends on your situation – sometimes, we have to refinance if you have debt, are getting divorced, etc. When it comes to rates and refinancing, refinancing may be right for you if the new interest rate is lower than your current rate and you plan to stay in your home long enough to break even on the refinancing costs. Also, consider factors like your financial goals and potential savings.

7. Can I refinance multiple times if interest rates continue to drop?

Yes, you can refinance multiple times if interest rates drop significantly each time and the savings justify the closing costs. Keep in mind though that certain lenders and loan types have rules and regulations surrounding refinancing timelines, so be sure to check those out.

8. Can I switch from an adjustable-rate mortgage to a fixed-rate mortgage during a rate cut?

Yes, you can switch from an adjustable-rate mortgage to a fixed-rate mortgage when interest rates drop. Most lenders offer this option.

9. Is it better to refinance to a shorter or longer mortgage term?

Refinancing to a shorter term can save you money on interest and help you pay off your mortgage faster, but it usually means higher monthly payments. A longer term reduces your monthly payments but increases the total interest paid over the life of the loan. Ultimately, the answer to this question will depend on your unique financial situation and which option will help you achieve your financial goals. Make sure to consult your financial advisor!

10. What’s the difference between a rate-and-term refinance and a cash-out refinance?

A rate-and-term refinance changes the interest rate, term, or both, without changing the loan amount, aiming to lower payments or pay off the loan sooner. A cash-out refinance allows you to borrow more than you owe on your home, taking the difference in cash, often used for home improvements or debt consolidation.

11. What fees and costs are associated with refinancing?

Refinancing typically involves closing costs, appraisal fees, and origination fees, which can range from 2% to 5% of the loan amount. Fees and costs may vary between lenders, so it’s important to do your research and compare your options. 

12. What impact do interest rate cuts have on the housing market overall?

Lower interest rates can stimulate the housing market by making homes more affordable, leading to increased demand and potentially higher home prices. Affordability helps new home buyers to enter the market and existing homeowners to refinance for a lower monthly payment. 

13. Will my monthly mortgage payment decrease immediately after refinancing?

Yes, your monthly mortgage payment will generally decrease immediately after refinancing to a lower interest rate, assuming all other terms and the loan amount remain the same.