Refinance When Interest Rates Are on the Rise?
Homeowners refinance their mortgage loans for several reasons, but most do it to lower their loan’s interest rate. This isn’t surprising: A lower interest rate means a lower monthly mortgage payment. And that can save homeowners thousands of dollars every year, depending on how much their interest rate falls.
But refinancing your mortgage could make sense even when interest rates are going up.
Cutting your monthly payment: You might refinance from a shorter-term mortgage to a new home loan with a longer term, such as a 30-year, fixed-rate mortgage. When you do this, you’ll lower your monthly payment because you are stretching out your payback period over so many more years. This could help if your monthly income falls or you are struggling to pay your bills each month. The money you free up on your mortgage payment could help you pay those bills and boost your financial health.
Here’s an example: If you are paying off a 15-year, fixed-rate mortgage of $310,000 at an interest rate of 5.98%, your monthly payment, not counting your property taxes or homeowners insurance, will be $2,612.
Say you’ve paid off enough of this current loan so that you now owe $275,000. If you refinance that amount to a 30-year, fixed-rate loan with an interest rate of 6.6%, your monthly payment, again not counting homeowners insurance and property taxes, would fall to $1,937.
That’s a savings of $675 a month or $8,100 a year. You could use that money to shore up your financial health.
There is a downside to refinancing to a mortgage with a longer term: You’ll pay more in interest because you are paying off less of your mortgage’s principal balance with every payment.
Slashing the amount of interest you’ll pay: That brings us to the second reason to refinance even if rates are increasing: to reduce the amount of interest you’ll pay on your mortgage. If you refinance a longer-term loan such as a 30-year, fixed-rate mortgage to one with a shorter term — such as 15 or 10 years — you’ll pay tens of thousands of dollars less in interest, depending on how long you hold onto your new loan.
This makes refinancing a shorter-term mortgage a smart move if you can afford the larger monthly payment that comes with this move. Look closely at your household budget. If you can comfortably fit a larger mortgage payment into it, refinancing to a shorter-term loan could reduce the amount of interest you pay over the long haul.
Say you are paying off a 30-year, fixed-rate mortgage of $325,000 with an interest rate of 6.5%. If you hold onto that loan for the full 30 years, you’ll have paid $414,685 in interest before paying it off. Say you now owe $225,000 on this loan. If you refinance that amount to a 15-year, fixed-rate loan with an interest rate of 5.98%, you’d pay a total of $116,352 in interest if you take the full 15 years to pay off your loan.
That’s a potential of $298,333 in savings on interest payments if you switch to a shorter-term loan. Again, you’ll have to determine whether you can afford the higher monthly payment that comes with this shorter term. Work with a financial adviser to find out what works best for you.