Thinking about refinancing? Act now – waiting until after October could be a costly mistake.
By Sarita Harbour September 19, 2014
If you’re thinking about refinancing, don’t delay or you could be in for a nasty surprise. Come October, interest rates could reach new heights, making your refinance more costly than you’d probably like.
Why? Well, if the economy continues to improve as predicted, the government plans to taper off their stimulus plan this October, according to the minutes of their June 17-18 Federal Open Market Committee Meeting.
Keep reading to find out how these plans could affect you as a homeowner and why you should consider refinancing before October.
The End of Federal Stimulus
As part of a stimulus plan to kickstart the economy after the financial crisis, the government introduced Quantitative Easing (QE), in which the government buys up mortgage-backed securities, according to a recent report by the Congressional Research Service.
The purpose of QE was to influence private interest rates, ultimately encouraging people to borrow money – and take out mortgages to buy homes, notes the report. As a result, interest rates will likely be higher come fall.
“All signs point to rates going up in the future, so it makes sense to refinance as soon as possible,” says Brian Koss, executive vice president of Mortgage Network in Danvers, Massachusetts. “As October approaches, I believe we will begin to see rates edge higher. For home owners, this could make refinancing more costly.”
Higher interest rates mean higher monthly payments, which not only affects new homebuyers but also current homeowners who want to refinance.
Slowing Home Appreciation
If you’re a homeowner looking to refinance, rising rates aren’t your only concern. Thanks to higher interest rates, it will become more expensive for homebuyers to borrow money, so fewer people will be able to afford to buy homes, says Casey Fleming, president of the Silicon Valley Chapter of the California Association of Mortgage Professionals.
Fewer buyers mean a larger inventory of homes to choose from, which slows down the appreciation of real estate value, Fleming explains. And lenders look at the value of your home when you apply to refinance your mortgage.
Specifically, in order to refinance, the magic number is an 80 percent loan-to-value ratio. But once the value appreciation of your home slows, your LTV ratio might become higher, which means more risk for the lender. So once rates increase, refinancing might be more difficult to get approved or will cost you more in terms of a higher interest rate.
Using Your Equity
While the rise of home values will likely slow down after October, you can reap the rewards of last year’s strong home appreciation by refinancing now.
In fact, your home may be worth more than you realize, says Fleming. “The opportunity to refinance may be more appealing today given the double-digit home price appreciation in many markets last year,” he says.
So how exactly can your home’s appreciation be an advantage in refinancing? As your home’s value goes up and your mortgage balance decreases with each payment, you have more equity in your home and your LTV ratio is lower.
The end result? You have more room to borrow against the home by refinancing to a higher mortgage amount than you owe at today’s low mortgage rates. Then you can pocket the difference.
For example, let’s say you owe $150,000 on a $300,000 house. You can refinance the mortgage for $200,000. Ideally, you’d get a lower rate on the $150,000 you still owe on your home and get a check for $50,000 to spend as you like – whether it’s to fund your child’s college education or pay for renovations.
Refinancing an ARM
If you have an adjustable rate mortgage (ARM), now’s the time to decide if you’ll stay in your home for more than five years. Payments on ARMs change as the interest rates do – if rates go up, your payment can too.
According to Koss, “If you have an adjustable rate mortgage and are planning to keep your current mortgage balance beyond five years, you should consider a longer term mortgage now before rates go up,” says Koss.
Some ARMs allow you to switch to a fixed rate mortgage at designated times. Your loan documents should include this information, as well as the formula used to calculate a new fixed loan mortgage rate, according to The Consumer Finance Protection Board’s Consumer Handbook on Adjustable Rate Mortgages.
If you did switch to a fixed rate mortgage, you may feel better knowing what your payment will be every month for the rest of the mortgage, according to The Federal Reserve Board’s publication “A Consumer’s Guide to Mortgage Refinancing.”
However, refinancing to a fixed rate isn’t the right option for everyone. For example, your new fixed rate may be higher than the advertised fixed rates, based on the formula of your loan, and some convertible ARMs also come with a conversion fee to switch from an adjustable to a fixed rate mortgage, says the guide.
So make sure you talk to your lender about what’s involved with switching from an ARM to a fixed rate mortgage before making the switch.