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Refinancing when rates are rising
Rising rates tend to discourage homeowners from refinancing, but there are good reasons to refinance even when rates are going up, and even if refinancing means paying a higher rate than you currently have.
“The direction of interest rates shouldn’t impact your decision. Instead, you should refinance when it makes sense to you and based on how long you expect to hold on to the mortgage and property,” says Brian Koss, executive vice president at Mortgage Network in Danvers, Massachusetts.
With that in mind, here are six scenarios for refinancing while rates are rising.
Looking to refi? Compare refinance rates on Bankrate.com.
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Lower your rate and payment
If you don’t already have a super-low rate, you might still be able to get a rate that’s lower than your current one.
“Rates in the 4 percent to 5 percent range are still very attractive,” says Chuck Price, vice president of lending at NEFCU, a federal credit union on New York’s Long Island.
You also should consider the costs. If your new mortgage had costs of, say, $5,000, and monthly interest savings of, say, $200, your payback period would be 25 months.
“If you planned to sell in 10 years, this would make sense, as opposed to if you planned to sell in two years,” Price says.
The risk is chasing a lower rate while extending your term, which could mean paying more due to the longer repayment period, says Kevin W. Hardin, senior loan officer at HomeStreet Bank in Scottsdale, Arizona.
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Lock in a fixed rate and payment
All mortgages come with an initial rate that’s either fixed or adjustable. A fixed rate never changes. An adjustable, or variable, rate can change over time. Adjustables, known as hybrids, have a rate that adjusts only after three, five, seven or 10 years.
Adjustable-rate mortgages, or ARMs, have monthly payments that can move up and down as interest rates fluctuate. Most have an initial fixed-rate period during which the borrower’s rate doesn’t change, followed by a longer period during which the rate changes at preset intervals.
An adjustable rate exposes you to the risk of a higher payment. The closer you are to an adjustment and the longer you plan to keep your home, the riskier the adjustable-rate mortgage is. If you refinance into a fixed rate, the risk goes away.
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Stop paying mortgage insurance
Private mortgage insurance, or PMI, protects your lender if you don’t pay back your loan.
You’ll usually have to pay for PMI if you make a down payment that’s less than 20 percent of your home’s purchase price when you buy or your equity is less than 20 percent of your home’s current value when you refinance. (VA loans guaranteed by the U.S. Department of Veterans Affairs don’t require PMI.)
Some loans allow you to stop paying for PMI once your equity reaches a certain percentage of your home’s value, either because you’ve paid down your loan or because your home’s value has increased. Other loans require PMI for the loan’s entire term unless you sell or refinance.
Refinancing from a loan with PMI to a loan without PMI might make sense even if your rate is higher because you won’t have to pay the monthly mortgage insurance premium, sometimes abbreviated as MIP.
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Remove a borrower
Whoever is a named the borrower on a loan is responsible for making the payments. That’s true even if you and your spouse get divorced and your divorce decree assigns responsibility for a loan you and your wife got jointly to you or her solely.
Your lender has no obligation to remove you or your former spouse from your loan, regardless of your divorce agreement. If you’re the one who’s solely responsible, your agreement might require you to refinance to remove your former spouse, even if rates are rising.
If you have a home equity conversion mortgage, or HECM, often called a reverse mortgage, and your spouse was too young to qualify or you got married after you got your HECM, you might want to refinance to add your spouse.
Otherwise, your non-borrower spouse might not be allowed to remain in your home if you die or move out, or for health reasons.
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Get cash to spend
Another potential reason to refinance is to extract cash from equity. The cash can be used for any purpose, such as remodeling or making repairs to your home, starting or expanding your own business, paying off other debt or paying medical, legal or education expenses.
Expensive needs and wants exist regardless of rates, which suggests homeowners might want to refinance to take cash out even if their rates are rising.
Whether cashing out makes sense depends on your perceptions of the benefits and risks.
“All good reasons to refinance can become bad if done at the wrong time,” Hardin says.
Another option might be to get a home equity loan or line of credit instead of a new first mortgage. The rate for your second loan might be higher, but the principal will be less and the term shorter.
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Get cash to invest
Rising home values create opportunities to refinance and extract cash to invest in other assets.
This strategy could make sense if you can pay your new mortgage without counting on your investment gains, take advantage of the income tax benefits, afford to lose the money you invest, have excellent credit and plan to keep your home a long time, says Mike Windle, financial adviser at C. Curtis Financial, an investment advisory firm in Plymouth, Michigan.
That’s a lot of ifs, and there are multiple risks as well. Your investment returns might not exceed your interest expense. You might lose a significant chunk of your principal. Or your house could decline in value and you might not be able to sell it for enough to pay off your loan.