Rising interest rates can mean many things for the U.S. economy, but one thing is always certain when it comes to homeowners: when rates go up, refinancing goes down.
With the Federal Open Markets Committee — the 12-member group that helps decide monetary policy as part of the Federal Reserve — set to meet on Dec. 13 and 14, mortgage rates could be on track to do something they have rarely done in recent years, which is to move higher. While a rise in mortgage rates is not ideal for the home refinance market, it calls more for a shift in tactics rather than completely giving up on the idea of refinancing.
5 ways to refinance when rates rise
Here are five ways you can think about refinancing when rates are rising:
- Shift to a shorter loan. 15-year mortgage rates have been running about 80 basis points below 30-year rates, so even if rates overall have moved a bit higher, there might still be room to lower your interest rate by shifting to a shorter loan. Also, even without dropping your rate a shift to a shorter loan should save you interest costs in the long run because you will be paying interest over fewer years.
- Consider variable rates for short time horizons. If you anticipate being able to pay of your mortgage in a few years, consider a shift to an adjustable-rate mortgage (ARM). These offer even lower rates than 15-year loans, and if you choose an ARM with a long initial reset period, you can reduce your exposure to rising rates.
- Take advantage of improved credit. The job market has gotten stronger in recent years, and now that you're a few years older perhaps your income and credit rating have improved from when you first got your mortgage. If so, this might help you qualify for a lower mortgage rate, and make refinancing worthwhile even though average rates have started to rise.
- Use refinancing for payment management. Lowering your mortgage rate is not the only reason to refinance. If you are having trouble making your monthly payments, refinancing to a longer repayment period can help make those payments more manageable. Even though this is likely to result in you paying more interest over the life of the loan, it is preferable to risking default. Another option is using cash-out refinancing for debt consolidation, because mortgages are still cheaper than most other sources of debt, such as credit cards.
- Do some comparison shopping. When rates are on the move, comparing mortgage quotes from different lenders becomes especially important. Different lenders are going to react to a rising rate environment at different times and to different degrees, so shopping around might make an especially big difference.
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Most of all, a rising rate environment calls for decisiveness about mortgage decisions. If you see a worthwhile opportunity, you need to act before higher rates eliminate that opportunity.
Richard Barrington, CFA, is a 20-year veteran of the financial industry, including having served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc.