In 2020, interest rates reached historic lows on multiple occasions, encouraging many homeowners to refinance their mortgages and lock in more favorable terms. But what about when interest rates are on the rise? Is that a sign that you should hold off on any refinancing plans?
The truth is that you should never try to time the market, and if today’s interest rates can help you achieve your unique financial goals, you shouldn’t wait to move forward. Let’s walk through how mortgage rates are determined and how to decide if now is a good time for you to refinance.
How are mortgage rates determined
When you click the "Apply now" button on a mortgage application, the interest rates you get in return are determined by a combination of market factors and personal factors.
Let's cover off on the market factors first. Broadly speaking, all interest rates are determined by the state of the economy and what the US Federal Reserve is doing in response. These benchmark interest rates tend to be higher when the economy is in a period of growth and lower when the economy is slowing.
Mortgage rates are also influenced by personal factors—including your credit score, the size of your down payment, and the type of property you're looking to buy or refinance. The type of mortgage you’re looking to acquire plays a role, too. For example, a mortgage with a longer loan term will usually come with a higher interest rate than a mortgage that you pay off faster. That’s because lenders see short-term loans as less risky investments, so they charge you less for borrowing the money.
What causes rates to rise?
To find out what makes interest rates rise, let's start with what made them hit historic lows on multiple occasions in 2020. When the economy shows signs of slowing—for example, in the midst of a global pandemic—investors will look to offload risky assets, like stocks and riskier bonds. In turn, they’ll put their money in things that are considered “safe,” such as US Treasuries—which are considered one of the safest investments in the world. When the price of Treasuries go up (from all the buying), the market determined interest rate, or yield, goes down.
The flip-side of this equation is that when the economy starts to show signs of growing, interest rates will follow suit. You can see this happening with the COVID-19 vaccine rollout, which is helping more people return to work. Positive news for the economy causes investors to move away from Treasuries, which drives the Treasury yield up, which drives interest rates up. (If you're interested, we have an entire article that gets into the weeds on this topic.)
The important thing to keep in mind is that rising interest rates do not have to get in the way of you achieving your refinancing goals. In fact, there are a number of instances when you may find that you are able to secure a lower interest rate than with your current mortgage with a refinance in these conditions. Let’s explore a few of them now.
5 times refinancing during a period of rising rates can be a good thing
1. You can consolidate other loans
Say you have student loans, medical bills, a couple of credit cards...basically, other debt that generally has higher interest rates than a mortgage. In this instance, you could choose to consolidate your debt with a cash-out refinance and pay the same interest rate across all loans. It works like this: You refinance your mortgage for an amount higher than your existing mortgage balance, and you “cash out” the surplus at closing. You can then use the extra money to pay off other bills—leaving you with one, lower-interest debt.
2. Your credit score improved
Woohoo! If you’ve boosted your FICO since you took out your original mortgage, you may qualify for a lower interest rate. It certainly doesn’t hurt to see what’s out there. If you’re able to find a less expensive loan, you could end up saving a lot of money. A difference of as little as 0.25% can work out to be thousands of dollars saved over the life of your mortgage.
3. You have more money coming in
You got a raise at work, your spouse got a raise, or your new job pays better: another woohoo! No matter how your financial situation got sunnier, a higher income means a lower debt-to-income ratio (DTI), which makes you a more attractive credit risk, which—you see where this is going—means you’ll have better refinance options. Better Mortgage offers loans to borrowers with DTIs as high as 50%, but you’re generally going to have more favorable interest rates with a lower DTI. Everyone’s financial picture is different, so you might need to talk to a refinancing expert about your personal circumstances.
4. You have a significantly lower loan-to-value ratio
You may also find that a refinance can help you lock in a lower interest rate if you've had a significant change to your loan-to-value ratio (LTV) since you bought your home. As a quick refresher: LTV is calculated by dividing the amount of money you have borrowed by the appraised value of your property—and it’s a major factor in determining your mortgage interest rate. If you’ve paid off a significant amount of your mortgage, or if your home has shot up in value (say, through home improvements), you likely have a much lower LTV than when you first moved in. In this instance, it could be worth exploring your refinancing options.
5. Your adjustable-rate mortgage (ARM) is about to reset
If you’re coming up on the adjustable part of your adjustable-rate mortgage within the next year or two, refinancing could mean that your rate would be guaranteed for longer than it is now, regardless of market fluctuations. You could choose to switch out your ARM for a fixed-rate mortgage, and get the peace of mind that comes with stable monthly payments over the life of your loan. Alternatively, you could refinance your mortgage for another ARM, and you’d still come out on top. That’s because a new ARM means a new period of fixed interest—which typically means at least 5 years of predictable monthly payments that won’t be affected by market fluctuations.
The bottom line
As with all financial decisions, refinancing your mortgage is deeply personal. We’ve walked through some of the scenarios when refinancing may be a good move, but you should always do the math and see if you come out on top. With that said, you shouldn’t be dissuaded by rising interest rates. In fact, if you’ve had your current mortgage for at least 12 months, you may find that a refinance can save you a significant amount of money—even with rising interest rates.
As we always say, the best time to refinance is whenever you can hit your unique financial goals. If you’re ready to get started, we can give you custom refinance rates in as little as 3 minutes.