Most mortgage shoppers want the lowest possible rate in recorded history. But rates fluctuate, and there are good reasons to refinance even when rates are on the rise or your new rate is higher than your old one.
It can also make sense to refinance when you end up with a higher monthly payment. Really!
Eight reasons to refinance to a higher payment or rate
While at first glance, accepting a higher mortgage loan rate or larger monthly payment seems unappealing, it is sometimes possible to benefit from a loan that carries a higher interest rate or payment than you had before.
1. Shorten your loan term.
A 15-year loan comes with a lower interest rate and higher monthly payment than a 30-year loan, all else being the same. If you can afford the higher payment, refinancing into a 15-year loan could save you tens of thousands of dollars in total interest expense, explains Ryan Leahy, sales manager at Mortgage Network, a mortgage loan company in Danvers, Mass.
2. Get rid of mortgage insurance.
If you bought your home with a small or zero down-payment, you may be paying for lender's mortgage insurance every month. If your equity has increased, refinancing could let you ditch the mortgage insurance and save enough to offset a higher payment.
"Let's say your rate is 1/4-percent higher," Leahy says. "If you can knock off $250 of mortgage insurance, you may have a net savings of $200 per month, even with a higher rate."
3. Consolidate debt.
Home equity lines of credit (HELOCs) typically have variable rates. If you have a HELOC, refinancing to wrap it into your first mortgage could eliminate the rate risk. This strategy can also work with credit-card debt and other loan obligations, which could have higher rates.
"You may be okay with taking a slightly higher rate on your first mortgage so you're not worried about the adjustable rate on the (other debt)," Leahy suggests.
4. Lock in a fixed rate.
If your have an adjustable-rate mortgage (ARM), refinancing could let you lock in a longer-term fixed rate.
How much you could save depends on how much market rates go up and when. Suppose you have a 5/1 ARM with a rate in the 3-percent range. Your new loan might have a rate in the 4-percent range and your payment might be higher, but if your ARM rate were to jump even higher than that, you could avoid a significant payment hike.
"You're biting the bullet early to prevent a disaster in the future, potentially," Leahy advises.
5. Remove a borrower.
Sometimes refinancing isn't by choice, but rather court order, such as when a couple divorces and one wants to keep the family home. The only way to remove an ex-spouse from a mortgage loan is to refinance.
"These folks may not be all that interested in refinancing the mortgage, but the ex-spouse needs to come off the loan and it's court-ordered to do so in a certain period of time," Leahy explains.
A new loan might also be necessary to buy out the ex-spouse's share of the home equity. That results in a larger loan amount as well as potentially a higher rate.
6. Re-lengthen the loan term.
Very old loans that carry above-market interest rates are rare, but Leahy says, some still exist. If your rate's in the 5-percent range or higher, refinancing might lower your payment, since you're starting with a new 30-year term. If your loan balance is very small, the savings might not offset the costs of refinancing.
7. Cash out equity.
Another reason to refinance at a higher rate is to cash out equity for home improvements or other purposes. Leahy recalls a borrower who gave up a $150,000 loan with a 3% rate, 15-year term and $2,200 monthly payment and instead got a $300,000 loan with a rate in the 4-percent range, 30-year term and $2,400 monthly payment. The new loan is more costly, but includes $150,000 that the borrower plans to use to rehab the home. Such a borrower should pay attention for future opportunities to refinance.
8. Improve then move.
Depending on how long you've been in your existing loan and the step-up in interest rate to a new loan, there may be little or even no increase in your monthly payment even if the mortgage amount is higher. As an example, let's say that you've been in your home for 12 years, started with a $200,000 loan at a 5% rate. Your principal and interest payment would have been $954.83 for the last 144 payments, and your remaining loan balance would be $146,853.
You think you will be selling in perhaps two years, and want to free up some money to spruce up the place to help ensure you get the highest price. You do a cash-out refinance to a new loan amount of $175,000 and free up about $28,000 to spend on home improvements and updates. Even with a rate of 5.125% -- a full 1.125% above your existing interest rate -- your monthly payment is $952.85, about two dollars per month less than you are now spending.
This has provided you with the money you need without any change in your cash-flow. However, it's important to keep in mind since your refinanced restarted your "amortization clock" all over again that total interest costs will be higher over time that if you hadn't refinanced. That said, since your time frame is limited, the effect of higher interest costs shouldn't be troubling.
It's always smart to shop around when you want to refinance a mortgage loan. Shopping can help you find a lender you like and a rate that works for your unique circumstances.
Related: Is a cash-out refinance a good idea?
This article was updated by Keith Gumbinger.
The above information is very much helpful and appreciated. Thank You!