What happens if mortgage rates drop after you buy?

Mortgage rates can be a moving target. Even after you've secured a home loan, the interest rate you're paying could become outdated if rates in the broader market decline. This can leave homeowners feeling like they're stuck with a higher-cost loan. Fortunately, there are options available if mortgage rates drop after you've already purchased a home.

In this article, we'll explore the steps you can take to potentially take advantage of falling rates and how to weigh the costs and benefits of refinancing your mortgage.¹

Key takeaways:

1. Once you’ve locked in a mortgage rate, that’s the rate you’ll pay – even if rates go down.
2. Many homeowners take advantage of lower rates by refinancing their mortgage, but it comes at a cost.
3. You can calculate your break-even point to see if refinancing is worth it.

How interest rate drops affect your mortgage

Dropping rates may or may not influence your mortgage. It all depends on the type of loan you chose and where you are in the borrowing process.

Adjustable-rate mortgage (ARM)

An adjustable-rate mortgage is a type of mortgage that comes with an interest rate that can change over time. Typically, you’ll hear these loans discussed using two numbers, such as a 5/1 ARM or 7/1 ARM.

The first of these numbers is the initial rate lock period. During this time the rate of the loan won’t change. The second is how frequently the rate can change once the introductory period ends. For example, with a 5/1 ARM, the rate remains fixed for five years and then adjusts once per year.

With an ARM, rising or falling rates can cause the interest rate of your mortgage to change. That also means your monthly mortgage payment will rise or fall.

Usually, the rate is set based on a benchmark rate plus a margin amount. Most loans come with rate floors and caps which set limits on how low or high your rate can adjust in one adjustment and overall.

For example, you might get an ARM at an initial rate of 5% with a rate floor of 4%, a cap of 11%, and a maximum adjustment of 2%. That means that your rate will never be less than 4%, higher than 11%, or move more than 2% in a single adjustment.

Fixed-rate mortgage

With a fixed-rate mortgage, the rate you get when you receive the loan is the rate you keep. If rates rise, your mortgage rate stays the same. If rates fall, your mortgage rate also stays the same.

This offers certainty because your monthly payment won’t change based on changes in the rate market. However, it also means you won’t benefit from falling rates without refinancing your mortgage to a new loan.

Mortgage rate lock

When you are applying for a mortgage, your lender may offer a rate lock option. This lets you lock in the interest rate a lender quotes you for a period, often 30 to 60 days, guaranteeing that you’ll get that rate no matter how the rate market changes so long as you finalize the loan within the agreed-upon period.

This can be beneficial for people who want to be sure of their budget while they’re shopping for a home and going through the closing process.

Mortgage rate locks do precisely what they say: lock in your interest rate. If rates drop during your rate lock period, you’ll still be offered the higher rate if you go through with the loan. To get the lower rate you’ll have to wait out the rate lock period or find a new lender.

Float-down option

A float-down option is an additional feature sometimes offered with rate locks. If your rate lock comes with this option, you may have the option to lower your locked-in interest rate if market rates drop during your rate lock period.

For example, imagine you get a rate lock at 6% with a float-down option. If rates drop to 5% while you’re going through the closing process, you can ask your lender to reduce your mortgage rate to 5%.

These options often come with caveats, such as only allowing you to use them if rates drop by enough, only letting you exercise the option once during the rate lock period, or coming at a fee, which can be between 0.25% and 1% of the loan amount.

Keep in mind that not every lender offers float-down options, so inquire when you start applying for loans to see if one is available.

Refinancing when rates drop: when does it make sense?

If you have a fixed-rate mortgage, the only way to benefit from falling rates is to refinance your mortgage to a new one. However, refinancing comes at a cost. You must pay closing costs and other fees during the process. Often, the total will be between 2% and 5% of the refinanced amount.

To decide whether refinancing makes sense, you have to make sure you’ll save enough money to cover the cost of refinancing. For example, if you have a $400,000 loan and pay $12,000 to refinance it but only save $10 per month, you won’t really be saving any money. On the other hand, if that refinance cuts your monthly payment by $200, you’re more likely to come out ahead.

Before refinancing, you’ll usually want to see a rate drop of 0.5% to 1% or more.

How to calculate your break-even timeline

Deciding whether refinancing is worth it is all about doing the math to see whether you’ll save money and how long it will take to break even after refinancing.

Continuing with the above example, imagine you pay $12,000 to refinance your mortgage and cut your monthly payment by $200. You can use this formula to see how long it will take to come out ahead:

Cost to refinance / savings per month = months to break even

In this case, it would take:

$12,000 / $200 = 60 months to save as much as you paid to refinance.

That means that you’ll save money overall so long as you keep the new loan for at least 60 months. The shorter the time to break even, the better. However, if you plan to keep your home for the long run, it can be acceptable to refinance even if the time to break even is longer.

Just keep in mind that rates could continue to drop and you’d have to pay costs every time you refinance. If you think rates are likely to keep dropping, you might want to hold off on refinancing until you’re less confident about future rate changes lest you miss out on further rate drops.

You can use a refinance calculator from Rocket Mortgage to see how refinancing may impact your mortgage payment.

FAQ

Before refinancing your mortgage to take advantage of falling rates, keep these questions in mind.

Should I refinance if rates drop?

Whether you should refinance if rates drop depends on many factors, such as how long it will take you to break even and how long you plan to keep your new loan. Only refinance if you’ll come out ahead in a reasonable amount of time.

How soon can you refinance a mortgage?

In theory, there is no limit to how often you can refinance your mortgage so long as you continue to find willing lenders. In reality, refinancing isn’t something you should do frequently due to the cost, so you wouldn’t want to refinance your mortgage for at least six or twelve months after getting your previous loan.

The bottom line: Do the math before refinancing when rates drop

If mortgage rates drop, you might want to consider refinancing your loan so you can take advantage of lower rates and the corresponding lower payments. However, refinancing comes at an upfront cost. Do the math to make sure that your monthly savings will offset that cost in a reasonable amount of time.

If you’re ready to explore options for refinancing, you can reach out to Rocket Mortgage and begin your loan application today.

¹ Refinancing may increase finance charges over the life of the loan.