If you have been paying attention to the news, chances are you have heard that the Federal Reserve cut interest rates at the July meeting. When banks can lend each other money at lower rates, it allows them to lower the annual percentage yields they offer on their consumer products. This encourages businesses to invest and consumers to spend more freely, ideally helping propel growth.

Investors and consumers may see lower rates on lines of credit that are tied to the prime rate, lower yields on savings accounts and CDs, and perhaps lower auto loan rates. While not the first to respond to lower rates, mortgage rates can also be affected.

Sure enough, mortgage rates have dropped, and we’re seeing rates around 3.5% for a traditional 30-year fixed mortgage, which makes this a good time to refinance your home. A lower interest rate can have a meaningful effect on your monthly payments, which will, in turn, affect your monthly cash flow. Refinancing can also potentially save you thousands of dollars a year.

Let’s say you have a mortgage balance of $250,000, and your current rate is 4.25% . Your mortgage payment is likely around $1,230 a month. If you were able to refinance at 3.5%, you could potentially reduce your monthly payment to $1,122, saving you more than $1,200 a year. Imagine if you were able to boost your retirement savings by $1,200 a year!

I’ve also seen lenders offer even lower rates with points. Points are costs that a lender charges you upfront for your mortgage. One point generally equals 1% of the loan amount borrowed (e.g., 1.5 points on a $100,000 loan would equal $1,500). Commonly, the more points that you pay up front, the lower the interest rate you will pay on your mortgage loan.

If you choose to pay points up front, you should make sure that you recover the cost while you are still living in your home. If you move before you recover the costs of the points, you don’t save any money. To calculate this, you divide the amount you pay for points by the amount you save on your mortgage loan. For example, let’s say on your $250,000 loan, you could pay $500 in points, lowering your mortgage interest rate to 3.375% . This interest rate would bring your monthly payment to $1,105, saving you $17 a month. It will take you roughly 30 months to recover the cost of the points (500 divided by 17 equals 29.4). If you plan on staying in your home for less than 2.5 years, you will lose money on the points that you paid up front. Keep in mind, this is merely an example that does not account for escrow, closing costs, or other lender fees. Your recovery period could be five or more years, so carefully consider your options before lowering your mortgage with points paid upfront.

Some homeowners might opt for a shorter loan term instead of lower payments. If you use the shorter term, you pay your mortgage off earlier; however, this won’t affect your current cash flow. In my opinion, when mortgage interest rates are this low, I believe investors are better off paying less per month for longer because they can make the difference up in their investments. Remember, the long-term average for the stock market is about 10% . You should be able to make more in the stock market than you will save in interest by opting for a shorter loan term.

William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial and a co-host on Atlanta’s longest running, most respected financial talk radio show “Money Talks” airing Saturdays at 10 a.m. on AM 920 The Answer. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.


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