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Does it make sense to refinance in a rising rate environment?

When mortgage interest rates are on the rise, refinancing may not be a financial strategy that is top of mind.  At first glance, it may not appear to make sense.  However, when you review in depth, you may find it to be very beneficial after all.

 

Here are 2 instances where refinancing may make sense even if you are moving to a higher interest rate:

 

A strategy for paying off higher interest debt:

If you have unsecure debt, such as credit card debt, you are most likely being charged an interest rate quite a bit higher than the current mortgage rates.  I encourage you to pull out your statements and look to see how much you are being charged. You should also know that most credit card interest rates are adjustable monthly. Therefore, as interest rates rise, you may find the rate on your credit cards increasing as well. Using equity in your home to pay off higher interest debt, may make sense for you.

 

A strategy for eliminating mortgage insurance:

When you first bought your home, you may have put very little down. In turn, you  pay a monthly mortgage insurance premium. Mortgage insurance premiums, though helpful in getting you into a home with little money down,  can add quite a bit to your monthly payment.  Some loan programs allow you to drop the mortgage insurance once you meet certain terms. However, others, such as FHA loans with a casefile after June 3, 2013, require you to keep the mortgage insurance for the life of the loan (unless you put down at least 10%.)  With the significant increase in home values, refinancing may make sense for you.

The best way to determine if refinancing in a rising rate environment makes sense for you is to get a clear picture of your current financial situation.

For instance, our example Tom has an interest rate of 3.875% on his current mortgage. Why in the world would he even consider refinancing to a higher rate of 4.125%? Well, let’s see.

 

Tom has accumulated about $20,000 in credit card debt.  The interest rate on the credit cards average around 15% and the rates keep going up making it harder and harder to pay off. 

 

Tom lives in Florida and he bought a home in 2017. Home values in Florida have increased quite a bit since then. He estimates his home is valued at around $500,000.

 

Tom currently owes $267,152, which means he has $231,848 in equity. 

Tom has an FHA loan. His interest rate is 3.875%, but he also had mortgage insurance of 0.85%, which is costing him an additional $207 per month. The mortgage insurance alone is causing his monthly payment to be more than it would be for a conventional loan at 4.125% with no mortgage insurance. 

 

Removing the mortgage insurance is reason enough to refinance.  However, with interest rates rising above 15% on his credit card debt, he decides to go ahead and pay it off, as well.

 

Refinancing is starting to make more and more sense, but we also need to factor in the costs involved. (There will be closing costs to refinance. If you have been told otherwise, read our blog post “catchy catch phrases“.)

There are different ways to structure your loan to cover the closing costs. You don’t necessarily have to pull funds out of savings to pay them. Luckily, Tom has enough equity that the closing costs can be rolled into the loan if he chooses to do so. This will increase his new loan balance a bit more but in the end he still saves $418 per month and will actually pay $86,000 less than he would have if he did nothing.

 

How did we determine all this? We put together a debt consolidation report for Tom’s specific situation. Feel free to view this interactive report. Note: you will be asked to provide your name and email in order to gain access to the report. However, that’s it.  

 

If you would like a report specific to your situation, we would be happy to do this for you. There is no cost for this service. Just ask!

Man with hand on chin looking at paper

Every attempt has been made to ensure that the above information is valid at the time of publication. Subject to credit approval. NMLS #318098.

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