Homebuyers

Why Homeowners are Refinancing Their Mortgages Despite Higher Rates

If you purchased a home or refinanced your loan with a record-low mortgage rate during the pandemic, you likely did so with glee.

Fast-forward a few years and you’ve accumulated debt, you need a new roof, or have some unexpected expenses you need to cover. You might want to tap into your home equity but are discouraged by higher mortgage rates.

Even though you have a low rate on your mortgage, there are some situations where refinancing your existing loan makes sense.

“Even if it may cost more for that debt in the long run…the freedom [a refinance] gives you now can allow you to make better financial decisions going forward,” said New American Funding Senior Mortgage Consultant David Nelson. He’s based in Champaign, Ill.

Cash-out refinances are often used by homeowners to consolidate debt. This is when you replace your existing mortgage with a new loan for more than you currently owe on your home. You can then pocket the additional money and pay it back in your monthly mortgage payments.

Second mortgages are just like they sound, an additional mortgage on top of your existing one. This can allow you to tap into your home equity through a new loan without losing the low mortgage rate on your original loan.

Homeowners may also consider a home equity line of credit (HELOC). This functions somewhat like a credit card and allows you to tap into the equity you have in your property through multiple withdrawals that you pay back over time.

“If you’re drowning in credit card payments, a cash-out refinance [may] help free up your monthly budget and give you some breathing room,” said Nelson.

Reason to refinance #1: Eliminating credit card debt

Eliminating high-interest credit card debt is one of the most common uses for a cash-out refinance. 

The average American household had $6,455 in credit card debt, according to a February report from TransUnion.

With average credit card interest rates running 23.99% in June, according to Investopedia, clearing credit card debt can be a daunting task. Those living paycheck-to-paycheck may struggle to pay down what they owe.   

“If you’re stuck making minimum payments, you’ll [probably] never get out of debt,” Nelson said.

Even homeowners with a mortgage rate under 3% who refinance to a new loan with a rate in the 6% range may find they’re paying less in interest than they would on a credit card.

Nelson admits that the same debt may objectively cost more when spread over decades of mortgage payments. But for many on tight budgets, lowering monthly expenses could be more impactful than lowering total expenses over time. 

The same logic applies to homeowners who want to do home improvement projects, pay for weddings or college tuition, or start a business.

If your alternate funding source is a high-interest personal loan or credit card, you may be better off leveraging the equity in your home at a lower interest rate.

That’s why it’s important to look at your personal situation and do the math to make sure you’re choosing the option that’s best for you.

Reason to refinance #2: Removing mortgage insurance

If you purchased your home using a Federal Housing Administration (FHA) loan or you made less than a 20% down payment, you may be paying mortgage insurance. This insurance is typically added to your monthly mortgage payment.

However, after you gain at least 20% equity in your home, you may be able to remove it by refinancing into a new Conventional loan.  

Homeowners who snagged a significantly lower interest rate during the pandemic may not benefit from refinancing if their only goal is removing mortgage insurance. That’s because they may be paying higher interest on the loan. Plus, they will pay fees to refinance.

However, those with a higher mortgage rate may wind up saving money. You may want to work with a loan officer to go through your finances to see if refinancing would make sense for you.

“It’s situational,” said Nelson.

Reason to refinance #3: Separating ownership

If you own your home with a partner, family member, or friend and need to take someone’s name off the mortgage, a refinance may be necessary.

For example, if you’re going through a divorce, one spouse may want to buy the other out of the home or keep the property solely in their name. Or a friend who purchased a vacation home with another friend may eventually want to sell their share of the property.

Unless you’re able to assume the existing mortgage, which isn’t always possible, generally the one keeping the property needs to refinance. This takes the other person’s name off the mortgage and protects them, so they’re not on the hook for paying the mortgage for a home they no longer live in. 

“When someone wants to leave, whether it’s a marriage or an owner, the rates may not matter,” Nelson said. “There’s no way around it.”

Reason to refinance #4: Moving from an adjustable-rate mortgage to a fixed-rate loan

Many homeowners with adjustable-rate mortgages (ARMs) eventually refinance into fixed-rate loans.

ARMs can be appealing because they typically offer a lower interest rate for an introductory period. This typically lasts five, seven, or 10 years. Then the rate resets based on current market rates. So, if rates rise, your mortgage payment can increase up to a certain pre-determined amount.

That’s why you may want to refinance into a fixed-rate mortgage, where you lock in the rate for the duration of the loan. Of course, you can refinance again if rates go down to take advantage of the new, lower rate. 

Reason to refinance #5: Lock in a lower mortgage rate

When rates do fall, many homeowners may be able to save money on their monthly payments through a refinance.

You will want to make sure the rate drop is significant enough to justify the closing costs you will pay to refinance your loan. And you will want to ensure that you plan to live in the home long enough to enjoy the savings.

David Nelson NMLS # 1718338