Should you ever refinance when rates are rising?
It’s no secret that mortgage rates are on the rise. In fact, according to Freddie Mac’s latest numbers, 30-year rates recently had their biggest jump since 1987 before reaching 5.81% on June 23.
If you’re a homeowner, it might have you wondering: Did I miss my opportunity to refinance?
Mortgage expert Ivan Simental tackled the topic on a recent episode of The Mortgage Reports Podcast — and what he says might surprise you.
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Should you refinance? That depends
To refinance or not to refinance? For some, Simental says, it’s probably not the best time. For others, though? It depends on their unique scenario.
“With interest rates on the rise, now is likely not an ideal time to refinance for many homeowners,” Simental says. “However, the math isn’t always as simple as comparing a new interest rate to your old one. You have to take into account some other factors.”
Those factors include:
- The length of time you plan to be in your home
- The total costs of your refinance
Specifically, Simental says, you want to make sure you’re in the home long enough to recoup your refinancing fees. “When you refinance your mortgage, it typically costs anywhere from 1.5% to 4% of the loan amount, though it depends on the state.”
That would be about $10,000 on a $500,000 mortgage loan. You’d want to be in the home long enough that your refinance saved you at least $10,000 to make that move worth it. This is called your ‘breakeven point.’
“Refinancing may not be the smartest idea if you plan on moving in the near future,” he says.
Five examples of when refinancing still makes sense
Despite rising interest rates, there are still scenarios where it makes sense for some homeowners to refinance. According to Simental, these reasons include:
1. Lower your interest rate
The biggest reason to refinance would be to reduce your interest costs.
“If rates have dropped since you purchased, you can do a rate-and-term refinance and just get a lower rate and payment,” Simental says. “Generally, it’s best if you can lower your interest rate by 0.5 to 0.75 percentage points — so from a 6% to a 5.5% or 5.25% rate.”
Even when rates hit 5%, there were still over a million borrowers who could lower their rates and save money with a refinance. That might be true if you bought your home before 2008 or if your finances have improved since you bought your home, helping you qualify for a lower rate now than you initially could.
You also want to make sure you’re in the home long enough that your new interest rate saves you more than the refinance cost you to execute.
Though you can technically roll your closing costs into your loan amount, they do add to your balance and long-term interest costs, so it’s important to do the math and ensure it’s worth it. A good mortgage advisor can help you run the numbers and see if it would make financial sense in your scenario.
2. Consolidate higher-interest debts
Refinances can also make for good debt consolidation options since mortgages typically carry lower interest rates than other financial products, like credit cards and personal loans, for example.
“You can use a cash-out refinance to tap into your home’s equity and pay off higher-interest rate debts,” Simental says. “You can use the cash to pay [those debts] down or off entirely.”
This would reduce your long-term interest costs and free up monthly cash flow, which you could then save or invest in other endeavors.
3. Get rid of mortgage insurance
If your current loan carries mortgage insurance, refinancing can help you get rid of PMI and reduce your monthly payment. You’ll just need to wait until you have at least 20% equity in the property (when your mortgage balance is 80% or less than the home’s appraised value).
Getting rid of mortgage insurance could save you around $1,000 to $2,500 per year on a $300,000 conventional home loan.
“If, over the last year or two years, your home’s value has increased and you now have that 20% equity, you can refinance and get rid of your private mortgage insurance,” Simental says.
On average, PMI costs about $30 to $70 per month for every $100,000 borrowed on a conventional mortgage. That means if you have a $300,000 home loan, removing PMI could save you around $90 to $210 per month or $1,000 to $2,500 per year.
With those kinds of savings, it may not take long to recoup your refinance costs and see a net financial benefit.
4. Move from an adjustable-rate mortgage to a fixed-rate loan
If you have a mortgage loan with an adjustable rate, refinancing could also make sense — especially if your fixed-rate period is about to expire.
“Let’s say you got an adjustable-rate mortgage over seven years, and you are on year 6.5 and your mortgage is going to adjust to a much higher interest rate soon,” Simental says. “What you would do is refinance and get it into a fixed 15-, 20-, or 30-year mortgage, and you don’t have to worry about that rate adjusting.”
Fixed rates are higher now than they were over the past two years. But they could go higher still — and homeowners who lock in at today’s interest rates might be glad their rate won’t adjust even higher later on.
5. Shorten your loan term
Shortening your loan term can also be a smart reason to refi. While moving from a longer-term loan to a shorter one (like from a 30-year to a 15-year term) won’t reduce your payment, it will reduce your long-term interest costs. It also may qualify you for a lower interest rate, which will save you even more over the long haul.
As Simental says, “It could save you thousands of dollars.”
When is refinancing a bad move?
Essentially, Simental says, if you plan to move soon and aren’t sure you’ll break even on your costs, it’s probably not a smart move to refinance.
If your credit’s poor, refinancing could also be ill-advised. “It’s about your credit being good enough to qualify for the right refinance loan,” Simental says. “After all, the best rates and terms go to those that have the best credit.”
If you’re not sure refinancing makes sense in your case, reach out to a mortgage professional for expert guidance. They can run the numbers and see whether refinancing would work in your long-term favor.
As Simental puts it, “Generally, if refinancing will save you money, help you build equity faster, or pay off your mortgage faster, it’s a good decision.”
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