When mortgage rates increase, the last thing homeowners want to do is consider applying for a new mortgage. But that could be a mistake, especially if you have equity in your home and are looking to reduce your debt payments and/or improve your net worth.
Over the last few years, we’ve learned that mortgage rates don’t go down forever. Mortgage rates have cycles, and in 2022 that cycle dramatically increased. Will it last forever? No, just like the low rates of 2021 didn’t last forever.
A big part of managing your wealth is understanding interest rate cycles. Even if rates are higher than what you’re used to, you don’t want to miss an opportunity to buy a discounted property since mortgage rates will be lower at some point in the future.
Before I get to examples of when it might make sense to lock in a higher mortgage rate, let’s first look at when you should avoid a higher mortgage rate.
Examples of When You Should Avoid A Higher Mortgage Rate
Mortgage rates are fluid, and when they move higher, demand for loan products dwindles. Here are three examples of when you should avoid a higher mortgage rate.
- If you have a 30-year fixed rate that is 1.00% (or more) below the current market, avoid doing a refinance and consider a Home Equity Line of Credit (HELOC), home equity loan, home equity investment or (if you’re an older adult) a reverse mortgage.
- If current mortgage rates are 2.00% or higher than your current adjustable rate, avoid doing a refinance if you have at least three years remaining on your fixed rate period.
- If you are considering a shorter term (i.e., going from a 30-year to a 20-year fixed rate), do not refinance into a higher rate. Just make additional principal payments sooner to reduce the amount you owe, which will shorten your term.
Avoid raising your mortgage rate if you fall under one of these examples.
Examples of When A Higher Mortgage Rate Might Make Sense
Below I’ll cover when moving forward with a higher mortgage rate might make sense. It’s important to remember that every situation is unique. If you fall under one of these examples, it might be worth looking at your options.
Moving From A Low, Adjustable-Rate Mortgage To A Stable Long-Term Fixed Rate
A low adjustable-rate mortgage can be challenging to give up, but if you are close to the end of your fixed-rate period, you might want to evaluate if it’s beneficial to lock a higher long-term fixed rate. Here is an example of a situation that might lead a homeowner to consider a higher mortgage rate.
Example
Four years ago, a homeowner locked in a 3% 5/1 adjustable-rate mortgage (ARM). The homeowner plans on staying in the home for the next five to ten years and would like to lock in a fixed-rate mortgage; however, a 30-year fixed rate is currently at 4.50%.
Once the rate adjusts on their 5/1 ARM, the homeowner’s new rate will be based on the Secured Overnight Financing Rate (SOFR) and a margin of 2.50%.
The homeowner looks up the current SOFR which is 3.75%. That means if the rate were to adjust today, it would move from 3.00% to 6.25%. If the homeowner can lock in a 30-year fixed at 4.50% today, it might be wise to take the higher rate now rather than wait and risk their rate moving to 6.25%.
It might make sense to decide to lock in a higher rate when your ARM has less than two years remaining in its fixed-rate period. It’s essential to compare the prevailing market rates to your potential adjusted rate and review the market outlook.
When Your Overall Debt Payments Are More Than You Can Handle.
Many Americans have too much unsecured debt. At the end of 2022, the total outstanding credit card debt was $930 billion, and the average credit card interest rate was 19.42%3. Since COVID, personal loans have increased dramatically. In the fourth quarter of 2021, the total amount owed was $167 billion, which increased to $222 billion by the fourth quarter of 2022. Some personal loans carry an interest rate of over 30%.
If you have significant unsecured debt, consider consolidating that debt into a new first mortgage even if it raises their mortgage rate. I understand wanting to hold on to a mortgage rate lower than the current market; taking a big-picture view of your total debt and the rate of interest you are paying might help you make a more informed financial decision.
Example
Let’s say you have a mortgage balance of $200,000 with a 30-year fixed rate at 3.75%, and you’re less than five years into your 30-year term. Your monthly mortgage principal and interest payment are $972.54.
Your credit card debt is $75,000, that has an average interest rate of 19% and your minimum payment is $1,937.50. And you have a personal loan of $10,000 with an interest rate of 15% and a minimum payment of $238.00. Your total unsecured monthly debt payment is $2,175.50. That is over $1,202.96 higher than your mortgage payment. Your total monthly debt payment (mortgage and unsecured debt) is $3,148.04.
Checking current mortgage rates, you see a 30-year fixed debt consolidation mortgage comes with a 5.50% interest rate, which is 1.75% higher than your current mortgage rate. If you consolidate all your debt into one loan, your total amount would be $285,000. At a 5.50% interest rate, your mortgage payment would be $1,618.20. That is $1,529.84, below your current total monthly debt payment. That’s a huge saving per month!
Does this mean you can now go out a buy a boat, take expensive vacations, and spend all that savings? Absolutely not. If you decide that the debt consolidation mortgage makes sense, here are two options.
Save, Save, and Save
If you were to take the $1,352.83 and deposit that amount every month, over five years, into a savings account, you would have $81,169.80. If you were to invest the money, you might have significantly more. Having over $80,000 to invest in a rental property is significant and can set you on the right path to success.
Pay Down Your Mortgage Balance
If you were to take your $1,352.83 monthly savings and applied it to your 30-year fixed mortgage payment, you would pay off your home in ten years and seven months. That means you’ve paid your mortgage nearly twenty years early, saving you over $308,000 in monthly mortgage payments.
The Opportunity To Purchase An Additional Property To Earn Additional Income.
Heading into 2023, the total value of the US residential housing market was $45 trillion. Which is roughly double what it was in 2013. This clearly shows that owning property remains one of the best ways to increase wealth.
Using your equity can help you achieve that goal of owning an additional property, even if mortgage rates are higher than your current rate.
Cash-Out Refinance
If you have equity in your home and don’t have enough cash on hand for the down payment, you may want to consider a cash-out refinance even if mortgage rates are higher than the current rate you have on your mortgage. I suggest considering these factors before doing a cash-out refinance.
- Are you buying a property below market value? This should be a big component of your decision-making process. An increase in your current mortgage rate might make sense if the property you buy is below market value.
- Does the property currently have a renter? Having a renter in place that is paying the prevailing market rent is a huge bonus. It will save you time, resources, and money.
- Does the increased interest rate make sense? Are you going from 3.5% to 6.5%? If so, that might be too significant. The increase should make financial sense.
- What are the prospects for lower rates in the next one to three years? Taking on a higher rate now is not a permanent commitment. Rates historically go up and down over the years, and refinancing into a lower rate at a future date is a possibility.
Cash-Out Refinance to Pay In Full
Do you have enough equity in your primary residence to buy an investment property in cash? Then, you should consider taking on a higher mortgage rate if the numbers work in your favor. Interest rates on rental properties are typically 1.00% to 2.00% higher than interest rates on a primary residence, so you could benefit by avoiding the higher rental property rate.
One mortgage on your primary at 3.50% and one on your rental at 5.50% might cost you more than going with one, larger loan on your primary residence, especially if the loan balance on your rental is similar to the loan balance on your primary.
One Loan Vs. Two Loans
Let’s say you currently owe $225,000 on your primary residence and have a rate of 3.50% with a monthly payment of $1,010.35 and want to buy an additional property. Here are your two options.
Option 1
You decide to take on a loan to purchase the investment property. Your loan amount is $350,000, your rate is 5.50%, and your monthly payment is $1,987.26. Combined with the mortgage payment on your primary, your total payment for both properties is $2,997.61.
Option 2
You decide to do a cash-out refinance to pay cash for the investment property. Your total loan amount is $575,000, your 30-year fixed rate is 4.25%, and your one monthly payment is $2,828.65, a savings of $168.96. If you have one payment instead of two, you’ll save $10,137.60 over five years and have a free and clear property.
And your free and clear asset can be used to buy another property if you choose to expand your real estate portfolio.
Historical Interest Rate Data
I previously mentioned that mortgage rates move in cycles. As a homeowner, you must know that locking in a higher mortgage rate does not mean you will have that rate forever. If you are taking on a higher rate now, the odds are in your favor that you’ll have the opportunity to lower your rate over the next two to three years.
Average 30-Year Fixed Rate Mortgage From 2012 – 2022
Here is the annual average for 30-year fixed mortgage rates from 2012 to 2022. As you will see, mortgage rates improved the following two to three years after a year or two of higher rates.
| Year | 30-Year Fixed Rate Average |
|---|---|
| 2022 | 5.34%  |
| 2021 | 2.96%  |
| 2020 | 3.10% |
| 2019 | 3.94% |
| 2018 | 4.54% |
| 2017 | 3.99% |
| 2016 | 3.65% |
| 2015 | 3.85% |
| 2014 | 4.17% |
| 2013 | 3.98% |
| 2012 | 3.66% |
Building Wealth During Periods of High Mortgage Rates
To build wealth, you should evaluate your entire financial landscape, look at each component, evaluate its impact, and decide to improve your net worth. If you have an adjustable-rate mortgage that has the potential to move significantly higher in the next six to twelve months, then it may be your best option to lock in a higher long-term fixed rate.
When it comes to your debt, it’s important to evaluate all of your debt rather than just focusing on your current mortgage rate. The fact is, it is not a permanent commitment to obtain a higher-rate mortgage. Opportunities to lower your interest rate should develop over time. To ensure you are in a good position to lock in a lower rate in the future, you’ll want to keep your transaction costs low.
