Home mortgage expenses are generally a large part of any family’s monthly budget. When mortgage rates are rising, many people are caught off guard and surprised by an increase in their monthly housing expenses. How can you protect your family’s budget against the uncertainty of rising mortgage rates?
Many analysts are predicting that mortgage rates will rise steadily during 2014, citing the Federal Reserve Bank’s plan to wind down stimulus activity as a major reason for the predicted increase. Higher fees for low-income home buyers are in the works, and a more stringent screening process for Fannie Mae and Freddie Mac loans means that fewer people will qualify for these lower-rate loans. Approximately two-thirds of home loans come through these two agencies. “It is generally held in the financial press that interest rates — and thus mortgage rates — are on the rise,” says Bennie D. Waller, Ph.D., professor of finance and real estate at Longwood University. “For example, we refinanced in June into a 15-year fixed-rate mortgage for 2.65 percent. A similar refinance now entails a rate closer to 4 percent today.”
Many people opt for an adjustable-rate mortgage when purchasing or refinancing a home. The initially lower rates make monthly payments smaller and often allow home buyers to purchase a more expensive home than they would be able to afford with a fixed-rate loan. As rates climb, so does your monthly housing expense — which can come as an unexpected surprise to even financially-savvy consumers.
“Anyone with an adjustable rate, not planning on selling in the near future, should be looking to refinance now,” Waller shares. ARMs [adjustable-rate mortgages] can have a significant impact on a family's budget. An upward adjustment in an ARM of 150 basis points or 1.5 percent could impact a monthly payment by as much as $200,” he warns. “For example, a 30-year, $200,000 ARM at 3 percent that got adjusted upward to 4.5 percent would increase the monthly payment by $170. Such an increase could drastically impact a family operating on a tight budget,” he adds.
Eric Small co-founded a small mortgage bank in 2002 that grew to hire 800 employees, selling $50 to $100 million in loan packages to Wall Street banks each month. He now works as a consultant for several mortgage banks in Orange County, California, in the areas of marketing, operations and compliance. “Homeowners that are currently in adjustable rate mortgages should highly consider refinancing within the next 12 months,” he says. “Borrowers that plan on living in the property or keeping it as a rental for more than 5 to 7 years should refinance into a fixed-loan product."
While this is a longer-term strategy, Small has a different take on mortgage holders who are planning to sell in the near future. “However, homeowners that are planning on selling the property within 5 years should consider refinancing into an adjustable-rate product that is fixed for 3 to 10 years before it begins to adjust. These products are typically .5 percent to 1.25 percent lower than the standard 30-year fixed,” he adds.
Is your home mortgage loan a fixed-rate loan? As interest rates begin to slowly rise, you may want to consider refinancing your fixed-rate loan if there would be enough of a benefit in doing so — before rates rise too high. In general, it makes financial sense to refinance your fixed-rate loan when the costs of refinancing (closing costs) can be offset by monthly payment savings in a relatively short period of time. For example, if refinancing your fixed-rate mortgage to a lower rate results in a monthly payment that is $185 lower than what you currently pay but closing costs are $2,000, it will take you almost 11 months to break even on the refinance. If you plan to stay in the house longer than that, then the refinance might make sense for you.
Keep in mind that refinancing your mortgage doesn’t change the amount you owe on the loan; it is a restructuring. If you had paid 12 years into your 30-year fixed-rate mortgage and you refinance to a lower-rate 30-year loan, your payments will be smaller, but the amount you owe is now spread out another 30 years. Homeowners should take all of these factors into account when deciding whether or not to refinance their mortgage loans.
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