Why Refis Are Spiking and How to Optimize Your 401k Target-Date Fund for Long-Term Growth

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Investing for retirement is one of the toughest tasks we have in our personal financial lives.

So many choices.

How can you figure out what's right for you?

Well, there's one option that can fairly be called a set it and forget it investment plan.

They're target date funds.

And today we're going to tell you all about them.

Welcome to NerdWallet's Smart Money Podcast, where you send us your money questions and we answer them with the help of our genius nerds.

I'm Sean Piles.

And I'm Elizabeth Ayola.

Later this episode, we'll be explaining what exactly a target date fund is and how to know if it's a good option for your retirement planning.

But first up, our weekly money news roundup, where we break down the latest in the world of finance to help you be smarter with your money.

Our news colleague, Ana Hilhoski, is back with a look at what's happening with the housing market.

We're seeing a spike in home mortgage refinancing right now, despite the fact that the Federal Reserve hasn't cut rates since the end of last year.

So rather than speculate, we have Kate Wood and Holden Lewis, two home mortgage experts at Norwallet, to unpack what's going on out there.

Welcome back, Holden, Kate.

Hello again.

Hey.

All right.

So what are you both seeing out there?

This summer we're seeing that about half of mortgages are refinances.

Now, I mean, that's not a ton of mortgages because hardly anyone is getting a mortgage nowadays.

You know, home sales are depressed.

But the fact is that about half of mortgages are refinances.

So, you know, we're talking a bigger piece of a shrunken pie.

Think like those mini pies that you get at like a gas station or a convenience store.

It's really not a lot of people who are applying for home loans, but refinance is getting a lot of interest because many of the people who bought homes in the last two-ish years are really antsy to try to get a lower mortgage rate.

So it's not surprising that people in that particular group want to refinance, but are rates really that much lower?

And how do you know when it makes sense to refinance?

Let's start with that second question.

How do you know when it makes sense to refinance?

There's all these different rules of thumb, but you know, the one I subscribe to, I guess, is that if

you can get a mortgage rate that's three quarters of a percentage point below your current rate, then you're probably in line for what's called a rate and term refinance.

And that's just simply you get a mortgage for the same amount that you owed at a lower interest rate.

And so that reduces your monthly payments and you save a lot of money over time.

Over time is kind of the key here because there was a point where lenders were getting really into offering buy now refi later deals because they were just trying to take the sting out of higher interest rates.

So, unless you got one of those, refinancing does cost money.

And so, it's really important to know that you are fairly certain that you're going to stay in the home.

Life happens, things could change, but at least your intention is not to move.

Refi closing costs are usually 2% to 6% of the loan amount.

So, for a rate and term, that's 2% to 6% of whatever you still owe on your mortgage.

So, not to get too mathy, but you know, say you've got $300,000 to go, you're looking at $6,000 to $18,000 just to complete the refi.

So if your goal is to save money, you're not really saving until the amount that you've saved from your rate drop is greater than what you spent to do the refi.

So we call that the break-even point.

It is pretty easy to calculate, but again, it can take years.

And so if you're really thinking, here's my break-even point, you know, you're looking at it, it's six, seven, eight years out, and you're like, oh no, I'm selling this home like within three years, that refi might not be worth it.

So you really should be staying in your home.

You should be looking ahead.

That's right.

And, you know, we recommend using NerdWallet's mortgage refinance calculator because that'll do the math for you, just kind of get you an idea of what that break-even point is.

And then you can just look into your future, like, how much longer am I going to be in this house?

Will it make sense?

Will I save money before?

I sell the house.

We'll add a link in the show notes to that calculator.

So given everything you've both said, said, who is the best possible candidate for home refinance right now?

Lately, mortgage rates have been stuck kind of between 6.5%

and 6.25%.

So, you know, you might be in the money to refinance if you have a mortgage with an interest rate of 7.25% to 7.5%.

So that would be a reduction of three-quarters of a percentage point.

And for listeners who are thinking, wait, what?

When did these people with these mortgage rates buy?

Like, please, please, let's remember that there have been plenty of times over the past 40 odd years when that would have been a dream interest rate for people.

So it's really only if you're looking at a recent timeline that you're just like, what?

Like, when did these people buy?

There was actually a brief period back in 2023, four and a half months from August to December 2023, there was a spike in mortgage rates and they were higher than seven and a quarter percent.

They even approached approached 7.75%.

So if your mortgage dates from that four and a half month period, you really might be in line to refinance and save some money.

And that's about it.

There was a couple of weeks in 2024, the end of April, the beginning of May, where mortgage rates were a little higher.

But, you know, there's just not a lot of people.

who are going to refinance, get a standard rate and term refinance and save money that way.

In other words, that's not really the reason people are refinancing nowadays.

It's not just to reduce their interest rate and their monthly payment.

In fact, kind of the opposite.

Forgive me, not an expert here.

If refinancing doesn't make sense for that many people, why are we seeing a spike in that demand?

So we've so far been talking about rate and term refinances, where your main goal is lowering your interest rate.

And I think for a lot of people, if they're thinking about refinancing, that's what they're thinking of, right?

Because, Because, you know, that's what you would do if you wanted to refinance a car loan or your student loans, for example, right?

You're lowering your interest rate.

With housing, the other most common type of refinance is called a cash out refinance.

So with a cash out, you're leveraging your home equity.

So the amount of your home that you actually own, the lender doesn't own it, you've paid it off, or it's home value that's accrued.

So you are leveraging that to borrow more than what you currently owe on the home.

Then at closing, you get the difference between what you still owe and that new loan amount as cash, hence cash out.

According to the Urban Institute, about 60% of refinances these days are cash out refinances.

And why would you do that?

You know, what are some of the reasons?

There's a few reasons.

You know, in a low-rate environment, you could potentially borrow money and reduce your interest rate.

I mean, that feels like a win-win.

Okay, so we're really not in that situation right now.

So what some people are doing is they might actually be replacing their current mortgage with a mortgage with with an even higher rate.

So, why would they do that when they're borrowing more money?

It might be to free up that cash to make renovations on their home, or they might be paying off higher interest debt.

I'm not recommending that, but a lot of people do that.

Like, you know, they might have a whole lot of credit card debt and they say, All right, I'm going to cut my cards.

I'm not going to use those cards anymore.

I'm not going to add to the balances, but I'm going to reduce my interest rate from, say, 21% to 7%.

So, there are probably, I'm assuming, plenty of people who are doing that.

I mean, usually if you're looking at doing something like home renovation or debt consolidation and you're considering borrowing against home equity to do so, in a lot of cases, you might look more to a second mortgage product like a home equity loan or a home equity line of credit.

But there are times where a cash out refinance would sort of be not even necessarily your best option, but your only option.

And a really big one is in divorce.

So when you get divorced, if you are both on that home loan and then one person gets the house in the divorce, the person who's keeping it has to refinance to remove the other party from that loan.

So in some cases where you need that to happen, so you need essentially a new loan and potentially you need to pay that person off some of the value of the home, right?

Their equity in the home, that might be a time that you'd be doing a cash out refi.

That makes a lot of sense.

So the question on a lot of people's minds right now is when interest rates will drop.

Now there's been some murmurings and speculation about the Fed's next meeting later this month.

And last month at the Kansas City Fed conference in Jackson Hole, Fed Chair Powell hinted that a rate cut could be coming soon.

But as we know, the Fed never makes any promises.

What do you two think?

The market seems fairly sure that the Fed is going to cut in September.

I just don't know about that.

I mean, I think that they might want to watch and wait a little longer to see what happens with inflation and employment.

So I think that there's a fair chance that they will just stand still in September and then maybe do something, maybe cut rates in late October.

If mortgage rates are what you're worrying about and you're looking at what the Fed's doing, it's really important to remember the Fed only controls one short-term borrowing rate.

They control the federal funds rate.

They don't actually set mortgage interest rates.

And mortgage interest rates go off of what the markets are doing, particularly what bond markets are doing.

Honestly, sometimes it kind of feels like rates are going off of vibes.

And so we've been in this sort of exuberant state where the markets are like, ooh, you know, feels like Powell gave us like a little wink wink that we might get a 25 basis point cut in September.

Mortgage rates kind of have already.

gotten to that point, right?

If you look at where they were in late July, around the time of that Fed meeting, and then going through August.

So, we've already seen a pretty significant decline there.

So, if you're thinking, like, oh, okay, the Fed's going to cut, it's going to be a Wednesday, like Thursday, I'm going to be online.

I'm going to be checking rates, you're probably not going to see a really big difference in mortgage rates.

So, they're not going to react as strongly as maybe some other financial products might.

Yeah, I always compare mortgage rates to like a reactive dog where, like, you can't really go on the barking because they bark at everything.

Like, they just bark constantly.

And so, you know, lenders are adjusting their rate offers throughout the day as different things happen in the markets, as world events happen.

Someone in the Fed gives a speech.

They change for literally everything.

And so by the time the Fed, who is like the opposite dog, right?

They are like the non-reactive dog, the quiet, delightful dog.

They're like the cat.

Yeah, they're like the cat, right?

They're like, I'm not going to make a noise until this is legitimately, I have a need.

By the time the Fed actually is like, okay, yes, we're doing a thing, mortgage rates have been doing the thing.

All right.

Well, I like that analogy.

Thank you both for coming on and helping us out today.

No, thanks for having us.

You're welcome.

And thank you, Ana.

All of this talk makes me really grateful that I locked in my mortgage in 2021.

I'm one of those smug people who's never going to reach out.

Such a flex.

Lucky.

Yeah, I'm one of those old people whose first mortgage was 8.5%.

But I'm sure your house was a lot less expensive also.

Oh my gosh.

It was in Toledo, Ohio.

And I think I bought it for five figures.

Brick house, two stories, basement, and a little creek in the backyard.

Would love to see what that's worth now.

Wow.

Well, up next, we answer a listener's question about what exactly a target date fund is and whether it's the best option for retirement savings.

But before we get into that, a reminder, listener, to send us your money questions.

Maybe you're waiting for the Fed to cut interest rates next year and you're wondering how you can plan towards buying a house or you yourself want to make sure that your 401k is invested in a target date fund.

Whatever your money questions are, please send them to us.

You can leave us a voicemail or text us on the nerd hotline at 901-730-6373.

For the people at the back, that's 901-730-N-E-R-D.

You can also email us at podcasts at nerdwallet.com.

In a moment, this episode's Money Question.

Stay with us.

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We're back and answering your money questions to help you make smarter financial decisions.

This episode's question comes from Jay, who sent us an email.

Here it is.

Hello, Sean and Elizabeth.

My name is Jay, and I am 35 years old and have a 401k target date fund set for 2055 through my main job.

I currently have around $29,000 in it and contribute about $200 a month.

If I decide that I want to keep working past 2055, would it be better to change my target date fund now or in 2055?

And am I behind on retirement based on my 401k amount?

I make $55,000 after tax working two jobs.

My second job is part-time, so no 401k.

Thank you for reading, Jay.

To help us answer Jay's question on this episode of the podcast, we're joined by NerdWallet Investing Writer June Sham.

Welcome back to Smart Money, June.

Hi, thanks again for having me.

So let's start by getting a little explainer of target date funds.

So June, can you talk with us about how they work and what folks find appealing about them?

So target date funds are a type of investment fund that take a set it and forget approach, which is why some people really like them.

If you're not a hands-on investor, a target date fund could be a solution, especially for a big goal like retirement.

In essence, what makes a target date fund so easy is that they do two things for you.

choose your investments and adjust the allocation of those investments over time as you get closer to your target date or retirement year.

So for example, in early years, the fund could be more heavily weighted towards high-risk investments like stocks to maximize growth potential, and then gradually shift to a more conservative mix of bonds and other lower risk assets to protect your account.

And then what about any drawbacks of target date funds as they compare to other options people might have to invest in?

The ease that you get with target date funds doesn't come without drawbacks.

The most immediate is that you lose the freedom of choosing your own investments and allocating your portfolio how you want to, which is important if you want to invest in some things and not others, and if you have a different risk tolerance compared to the fund.

Fees and expenses can be another issue, especially if you're investing in a target date fund through a 401k since you're not able to choose a planned provider.

As convenient as target date funds are, it's also important not to be totally hands-off.

I'll link an article in the show notes about how to evaluate and invest in target date funds, as well as what to consider during annual check-ins.

June, you mentioned fees and expenses, which are always an important part of choosing and managing investments.

How do the fees and expenses of target date funds funds compare to those of other investment options?

This can be a point of critique for target date funds sometimes.

Yeah, that's very true.

Fees and expenses for target date funds can be higher than other investment options.

For context, ETF expense ratios for broad SP 500 funds can go as low as 0.03% or even 0% for some fidelity total market funds.

In comparison, while the industry average for target date funds has been trending downward, it was 0.29% in 2024 according to a Morningstar report.

But we were able to find some expense ratios below 0.1%, which goes to show that there is a wide range of fees depending on the investment strategy, investments within the account, and more.

So if you're comparing target date funds, make sure they're as similar as possible.

All right, well, let's get to the core of Jay's question.

If they think they'll end up retiring later than 2055, would it be appropriate to push out their target date maybe to, let's say, 2060?

I know that target date funds generally have a bit of a wiggle room in the retirement retirement date.

So if Jay retires in 2056 instead of 2055, then that's probably not a big deal, right, June?

Yeah, that's right.

If he plans to retire before or after 2055 by about a year, choosing a 2055 target date fund probably won't be an issue, but five years might, because by 2055, their fund might be at its most conservative mix.

On one hand, it's a pro because it's helping protect their account against market fluctuations when they're very close to retirement.

But on the other, it's a con because they might be losing out on five years of investment growth.

To better answer their question, we can go back to how a target date fund adjusts its investment allocations over time.

It's also known as the fund's glide path.

Every target date fund, even ones with the same year, have their own approach, everything from where the ratio between high and low risk investment begins, to how it shifts over the years, to where it ends up, both closer to and at the retirement year.

So, when choosing a target date fund, look at the investments within the fund, but also consider the glide path.

Do the asset allocations freeze once you hit the target year?

That's considered a two-glide path.

There are also through glide paths where the allocation continues to adjust after the target date.

In Jay's example, it sounds like a through glide path could provide more flexibility.

Something else I want to bring up here is that a lot can happen between now and 2055.

Life changes, career and salary changes, all of that could affect initial plans for retirement.

I'm really curious to know what you think, Sean, as a certified financial planner.

What are your thoughts on how people should approach changes and their retirement plans?

Well, you're right that folks will generally want their investments to get more conservative as they approach retirement.

And I really want to emphasize, June, what you said about having a target date fund that goes to retirement versus through retirement, because investing for retirement doesn't stop once you retire for the most part.

Unless you do something like roll your retirement account balances into an annuity, we'll often have to keep our money in the stock market so it can continue to keep up with inflation and sustain our lifestyles.

And in the years before retirement, a lot of things are going to happen, things that are both in our control and totally out of our control.

So the advice is generally to focus on what you can control.

In this case, by continuing to invest what you can for retirement, that's going to provide at least some semblance of stability amid all of the uncertainty of the world.

Another thing I wanted to touch on is Jay's question around when and if they should change the target date fund, whether they should change that date closer to 2055 or sooner.

It seems like based on what you've said so far, June, that they would maybe want to look at where they are perhaps in 2045 and think if they want to work those extra five years at that point.

And then maybe at that point, reallocate what their target date fund is.

So that way the account itself can rebalance the investments over time so that they do have those extra five years to keep investing and growing their retirement fund.

Yeah, definitely.

They are not locked into whatever they choose now.

They can always adjust closer to their retirement date.

All right.

So let's talk about the other investment options that people have to invest in for retirement beyond target date funds.

June, can you give us a rundown of the most common, maybe let's say three or five kinds of investments that people might come across in their 401k or an IRA?

In addition to target date funds, most 401k plans and IRAs will let you invest in mutual funds, which are a basket of investments selected by portfolio managers, index funds, which are a type of mutual funds, but track an index like the SOP 500.

and exchange traded funds or ETFs, which are similar to mutual funds, but can be traded throughout the day.

In IRAs, you can also invest in individual stocks and bonds, which is great if you want to build your own portfolio and manage your investments yourself.

Okay, well now let's get a little personal, you guys.

June, Elizabeth, do you guys invest in target date funds and your retirement accounts and why or why not?

I do have my 401k in a target date fund.

I'm definitely teams hands off at the moment for my retirement accounts and it helps relieve a lot of the anxiety of managing my account.

Me too, me too.

I do as part of my 401k as well.

And I personally love that target date funds adjust risk according to your age or they become more conservative over time.

I am also a lazy investor.

So it's nice to know that the fund does the work for me.

Yeah, I'm in the same boat.

And what I'm paying in fees feels well worth the peace of mind knowing that my investments are on track and will be rebalanced over time.

And if I get to a point where I want to be more hands-on with my retirement account investments, a huge perk of accounts like 401ks is that I can buy and sell investments in the account without having to pay taxes, like you would if you were selling an investment in something like a taxable brokerage account.

But one thing that I find really interesting is that the three of us here spend a lot of our time managing and thinking about investments and how people can manage their own investments.

Yet we are all team lazy retirement account investments.

So I think that goes to show that sometimes you don't have to overthink the stuff.

Just invest in a way that works for you and maybe don't fuss over individual stocks too much.

Absolutely.

And that knowledge is what got me to start investing.

And like you said, stop overthinking.

So knowing knowing how much you need to contribute to a retirement account can be just as important as which investment you choose for the account, whether that be a target date fund or another investment option.

Can you give us a reminder of how people should be thinking about the amount of their income that they contribute to retirement accounts, June?

I really love this question because I recently revamped a lot of NerveWallet retirement prep articles to be more comprehensive, so it's all very fresh.

When it comes to using income as the basis for how much to contribute to retirement, there's two approaches, starting with how much of your income you can put aside now or how much of your income you'll need to replace in retirement.

The first is pretty simple.

Most experts recommend putting away 10 to 15% of your pre-test income towards retirement.

The second is the 80% rule, which says you should aim to replace about 80% of your pre-retirement income every year in retirement.

So let's say you make $100,000 annually now.

You'll need about $80,000 every year in retirement.

So given these different options, how do you think folks should think about which one might be best for them?

Whichever approach you use, I highly recommend using a retirement calculator to stress test your numbers.

With a 10 to 15% rule, it'll help you see how much you'll have by the time you reach retirement.

And with the 80% rule, it'll help you estimate how much you need to contribute now.

The biggest caveat is that both of these are just guidelines.

A lot of people set aside more or less than these recommendations or use a completely different approach.

Everyone has a different idea of what they want their retirement to look like and what financial obligations they might have, whether it's now or in the future.

and so the steps they'll take will be different for more on retirement planning i'll link another article in the show notes for reference jay also asked if they're behind on their retirement savings they're 34 make 55 000 after taxes and have about 29 000 in their retirement account there are some retirement savings benchmarks that suggest that you should have between one and one and a half times your salary saved by age 35.

Now, Jay isn't quite there yet, but they have plenty of company with this.

According to the survey of consumer finances, the median amount that people under 35 have saved for retirement is just under $19,000.

And for those 35 to 44, that amount is $45,000.

So, June, what are your thoughts around how people should think about saving for retirement if they aren't quite where they quote unquote should be given their age?

To be honest, these metrics are really tough because on one hand, they're just facts.

But on the other, it's only natural to want to know how we compare to other people.

And if we see that we're not where we should be, that can bring a a lot of mixed feelings.

At the end of the day, results from surveys and benchmarks like these can be helpful in defining our goals, but they should not be our goals, if that makes sense.

Instead, it's more important to estimate how much you need for retirement based on your own personal situation and aspirations and gauge where you are in relation to that number.

If you're not quite where you want to be, just being aware is helpful because then you can make a plan to change that.

And know that even if you can't catch up immediately, you can do it slowly and within your means.

And that is better than doing nothing at all.

June, do you have any final thoughts you want to leave our listeners with?

Honestly, worrying about having enough of retirement is very stressful for me too.

It is also so easy to get discouraged or feel bad about yourself in the comparison game because there is always going to be someone who seems like they're in a better position than you or they already have everything that you want.

In these moments, I try to bring it back to what's within my control and ask for help when I need it.

Lastly, patience is not my strong suit at all, but it is key for investing here.

Compound interest is what we're banking on to grow our wealth, and that takes a lot of time.

That's true.

Well, June, thank you so much for coming on and talking with us.

Thank you again for having me.

That's all we have for this episode.

Remember, listener, that we are here to answer your money questions.

So turn to the nerds and call or text us your questions at 901-730-6373.

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This episode is produced by Tess Wiglin and Ana Hilhoski.

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