Low mortgage rates are most borrowers' first priority when refinancing. But there are a surprisingly high number of circumstances in which it can make sense to refinance to a higher rate. Some of those are beneficial within a sound financial strategy, while others are less desirable, but are made necessary by distress.
Cash-Out Refinance for Debt Consolidation
Sometimes people build up large amounts of high-interest debt on credit cards or similar, and the monthly payments become overwhelming. In those circumstances, it may be necessary to consolidate debt, just to keep the household's collective head above water. And a refinance could slash monthly outgoings, even if it involves moving to a higher mortgage rate. That could transform life, making it once again possible to balance the family budget, and lifting the crushing worry and stress unmanageable debt brings.
But be warned: This is a terrible move, according to financial theory. To start with, it's almost certain to cost you far more in the long term, and not just because of the high closing costs that come with any refinance. Interest on even the lowest mortgage rates adds up over decades, and, if you use mortgage calculators to model your options, you'll find the total price you pay for this type of debt consolidation is going to be high. As seriously, you're transforming unsecured debt into secured debt, meaning you're raising your chances of facing foreclosure if things go wrong again. And, unless you address the spending issues that got you into the mess in the first place, it's quite likely things will go wrong again.
Of course, if you're desperate enough, none of those drawbacks will bother you at all. No price is too high to pay for a second chance. But it is a good idea to spend some time exploring your options (maybe a home equity loan, though that too is secured debt), modeling how those are going to work in dollars and cents, and perhaps chatting to a reputable, professional debt counselor.
Cash-Out Refinance for Other Purposes
Suppose you suddenly find yourself facing a big expense, relating, perhaps, to an illness, a wedding or a shortfall in a college fund. These are the sorts of events that often trigger a cash-out refinance. But how sensible is it to follow that course if current mortgage rates are higher than the one you're currently paying?
Well, that depends how much higher, and, again, it's easy to do a little basic math using those mortgage calculators to establish by how much your monthly payments are set to rise, and – as importantly – how big the hike in your total interest payments is going to be over the lifetime of the loan. Compare what you find with the same figures for a home equity loan. True, the rate on that is almost certainly going to be higher than on your new mortgage, but you're likely going to be paying it on only a small part of your secured borrowing and for a relatively short time. Oh, and closing costs are typically lower on those home equity loans.
If you have plenty of disposable income (spare cash left over after you've paid all your bills and expenses) each month, and are reasonably confident that will remain the case, you might consider a cash-out refinancing to a 15-year fixed-rate mortgage (FRM). That should see your monthly payments rise, but would slash the total interest you pay, not only because you'll normally get a lower rate than you would for a 30-year FRM, but also because you're probably borrowing for half the time. Better yet, you could be mortgage free in 15 years! If you can stand the higher payments, that could be the smartest move of all.
To Avoid ARM Ache
If you have an adjustable-rate mortgage (ARM), and you think mortgage rates are likely to rise soon (not an unreasonable belief), you may want to fix your rate before hikes kick in. That involves refinancing your ARM to an FRM, probably at a higher rate.
This may be a good idea. However, it's still worth using those mortgage calculators (don't forget closing costs) to work out precisely how good. Remember, most ARMs are now hybrids, meaning their mortgage rates are fixed for an agreed initial period, and that rate hikes are usually capped, often with limits on the amount they can rise both overall and at any one time. If you plan to move anyway within a few years, you may find those caps mean you're better off not refinancing. Having said that, most people with ARMs who are intending to remain in their homes for many years may find a refinance a good deal.
It's neither cheap nor quick to refinance, and the most common reason for doing so is to move to a lower rate. Still, there really are times when it can make sense to refinance to a higher one. Just make sure you've fully explored your options and understand the implications before you go ahead.