Homebuyers

Small Interest Rate Drops, Big Savings: What a 1% Difference Means for Mortgages and Refinances

Mortgage interest rates have been on a wild ride over the past few years, leaving homebuyers and homeowners wondering when they’ll catch a break.

The good news is you don’t need to wait for rates to plummet to historic lows to benefit from a rate drop. Even a modest decrease, such as a single percentage point, can unlock significant savings.

“On a purchase, a one percentage point decrease in the rate can bump up the buying power or get the [lower] payment [the buyer needs] to move forward with the purchase,” explained Amber Ernst, a sales manager at New American Funding based in Bettendorf, Iowa. “It’s also substantial for a refinance.”

Rates hovered just above 6% in late January, down almost a full percentage point from a year ago, according to Freddie Mac data. While that’s significantly higher than they were during the pandemic, when they fell below 3%, it’s also lower than when they neared 8% in the fall of 2023.

Those lower rates can reshape affordability and make refinancing more attractive.

Below, we’ll break down how much a one percentage point drop could save you.

How a 1-percentage-point interest rate drop impacts homebuyers

A percentage-point rate drop may not sound like a big change. But it can have a large impact on:

• How much you spend on interest over the life of the loan
• The size of your monthly mortgage payment
• How much you can afford to spend on a home

Impact of lower rates on total interest spent

For instance, let’s assume you have a $400,000 fixed-rate, 30-year loan. Here’s how much you’ll spend in interest over the life of the mortgage at various rates:

In this scenario, you may save nearly $95,000 if rates dropped from 7% to 6% for a 30-year loan.

Savings vary by loan size, but the takeaway is clear: Even just a single percentage point shaved off a rate can save tens of thousands of dollars over time.

Impact of lower interest rates on monthly payments

Seeing how much you’ll save over 30 years is great, but those long-term numbers can feel abstract. A clearer way to understand the everyday impact of a lower rate is to look at how a one-percentage-point difference affects your monthly mortgage payment.

Using the same $400,000 loan example, here’s how monthly payments (excluding homeowners insurance, property taxes, and private mortgage insurance) compare at rates from 5% to 8%.

In this scenario, a rate drop from:

• 8% to 7% saves $274 a month.
• 7% to 6% saves $263 a month.
• 6% to 5% saves $251 a month.

“A few hundred dollars a month is a gamechanger for most people,” Ernst agreed.

For many households, monthly savings this large could free up cash for an emergency fund or even investments. For example, investing $250 a month for 30 years at a 7% average rate of return could grow to roughly $294,000.

“Some people can also take those savings and just pay the loan off faster [with additional principal payments] than anticipated,” Ernst added.

Impact of lower rates on buying power

A drop in mortgage rates can also increase buying power. And as home prices have gotten higher in recent years, that could be crucial.

For instance, the monthly payment on $400,000 loan at 6% is $2,398. If you can obtain a 5% rate instead, you might be able to qualify for a $450,000 loan with virtually the same monthly payment ($2,416).

How a one-percentage-point mortgage rate drop impacts homeowners

Current homeowners can also benefit from a one-percentage-point rate drop, especially if they bought when rates were higher. For instance, reducing the rate on a $400,000 loan from 7% to 6% saves $263 a month through refinancing.

Before moving forward, however, you need to calculate your break-even point. Because refinancing typically comes with closing costs (often between 2% and 6% of the loan amount), the overall savings aren’t felt immediately, even if the monthly payment goes down.

To find your break-even point, divide the total refinance costs by your anticipated monthly savings. The result indicates how many months it will take to recoup the upfront cost.

If you continue to live in your home beyond that break-even point, you should see some savings.

How you can lower your mortgage rate

Mortgage rate changes are largely driven by economic forces you can’t control, such as monetary policy, the health of the economy, and inflation.

That said, borrowers aren’t completely powerless. Here are a few ways you can get a lower rate:

• Improve your credit score: Higher credit scores can often help you lock in a lower rate. You can improve your credit score over several months by paying down outstanding debts and keeping up with on-time payments.
• Buy down your rate: When shopping for a mortgage, ask each lender if you could purchase discount points, or mortgage points, to “buy down” your rate. Generally, you can pay 1% of the loan amount to reduce your rate by a quarter of a percentage point. That means you’d pay an extra 4% of the loan total at closing to lower your rate by a whole percentage point. This may be costly upfront, but it could save you a lot of money in the long run if you plan to stay in the home.
• Get an adjustable-rate mortgage: Adjustable-rate mortgages (ARMs) generally start with a lower interest rate. But after a set number of years, the rate becomes variable and could go up or down up to a certain cap. That said, you could lock in a temporary low rate with an ARM and refinance to a fixed-rate mortgage down the road, especially if you expect rates to drop within a few years.
• Get a shorter-term mortgage: Rates tend to be lower on shorter mortgages, such as a 15-year fixed mortgage. Just keep in mind: A shorter repayment term means higher monthly payments.

Amber Ernst NMLS # 406037