Despite current interest rates, which are well above pandemic-era lows, some homeowners are consciously deciding to refinance and give up their lower rates.
Data from the Federal Housing Finance Agency shows that 78% of mortgage holders sit below 6% interest, so why would anyone choose to refinance into a higher-rate loan?
It may seem counterintuitive – after all, you typically refinance to lower your interest costs. However, there are some scenarios, such as tapping into home equity or extending your loan term, in which refinancing at a higher rate may actually make sense.
Can You Refinance When Rates Are Higher?
Yes, you can refinance when rates are higher. Lenders do not require that you reduce your interest rate to refinance your home. While commonly associated with lowering your rate, refinancing is actually about restructuring debt. Sometimes this can mean incurring higher interest costs.
Ultimately, choosing to refinance at a higher rate involves considering the trade-offs to make the right decision to reach your financial goals.
For example, you might be able to lower your monthly payments by extending your loan term, though this means paying more interest over the life of your loan. Similarly, you may access a lump sum of cash to meet your immediate needs, but you can then expect your monthly payments to rise, sometimes considerably.
Note: While lenders won’t prevent you from refinancing to a higher rate, some specific loan programs, most notably the FHA streamline refinance and VA IRRRL, may require your new rate to be lower unless you switch from an adjustable-rate to a fixed-rate loan.
Why Someone Would Refinance into a Higher Rate
What are a few of the reasons why someone would refinance into a higher rate? Let’s take a look at some real-life situations where you could want to – or need to – refinance, even if rates are higher than what you’re currently locked into.
Divorce or Separation
Refinancing is often necessary after a divorce or separation to remove a departing partner from the mortgage. In many cases, this could be a court-order requirement of the settlement agreement. While lenders may occasionally let you remove someone from your mortgage through an assumption or loan modification, refinancing is frequently the only way.
Sometimes, borrowers use refinancing as a strategy to buy out the equity share of the ex-partner no longer residing in the home. Many lenders even offer special equity buyout refinances explicitly for this purpose.
Accessing Home Equity
Sometimes, the ability to access home equity is worth the trade-off of paying a higher interest rate on your loan. This could be when using your equity to consolidate other high-interest debts, effectively lowering your total monthly costs, or to meet an urgent need for a large sum of funds.
It’s important to note, though, that other equity-accessing options, like home equity loans and home equity lines of credit (HELOCs), are often a wiser decision than refinancing out of a low-rate mortgage.
However, these second mortgages have higher interest rates, which could cost you more overall depending on your existing loan balance and the amount of equity you need to access. As with most financial decisions, the right choice varies based on your unique individual situation. A blended rate mortgage calculator can help you compare options.
Resetting Your Loan Term
Refinancing into a higher interest rate doesn’t inherently increase your monthly payment. Depending on your loan balance and remaining number of payments, resetting your mortgage to a longer term may lower your monthly costs and improve cash flow.
The trade-off here is that, because of amortization, a larger portion of your payments are allocated to interest costs, with less reducing your mortgage balance. Plus, if you plan to keep the loan for an extended period, you’ll wind up paying far more in interest over the life of the mortgage.
Still, refinancing at a higher rate and resetting your loan term can make sense if you have an immediate need to improve your cash flow, especially if you plan to sell your home and pay off the loan in the near- to mid-future.Improving Payment Stability
Another situation in which homeowners may choose to refinance at a higher rate is when they currently have an adjustable-rate mortgage (ARM) and want or need the stability of a fixed-rate loan.
This could be when borrowers expect overall interest rates to rise drastically in the near future, or when they’re approaching the end of their ARM’s introductory period and likely to see their interest costs jump above the current fixed rate.
What Happens When You Refinance at a Higher Rate?
So, what exactly happens when you refinance at a higher rate? The reality is that this will depend largely on your individual situation and the reason for refinancing.
For starters, your monthly mortgage payments may increase or decrease, depending on:
- How much you’ve paid down your current loan
- Whether you borrow against your equity
- The severity of the change in interest rates
- If you spread your debt out over a longer term
Most borrowers who refinance at a higher rate choose to extend their loan term, effectively resetting the number of payments they must make, though this is not always the case.
One constant, however, is that refinancing to a higher interest rate will increase the total interest you pay over time, whether through making payments for a longer period or by increasing your loan balance.
Examples of Refinancing Into a Higher Rate
How might refinancing into a higher rate play out in the real world? Let’s consider a few example scenarios to show what the numbers could look like if you refinance out of a below-market rate.
Example #1: Increasing Your Loan Balance With a Cash-Out Refinance
For this example, let’s assume you took out your existing 30-year loan five years ago at a 3.75% interest rate with an initial balance of $300,000. You currently pay $1,389 per month in principal and interest costs, and your remaining loan amount is around $270,000.
You plan to do a cash-out refinance for $350,000 at a new rate of 6.5%. You’d receive $80,000, minus closing costs, but your new monthly payments would increase to $2,212.
Example #2: Using Your Equity to Pay Off High-Interest Debts
Here, we use the same scenario from the first example, but take a look at the broader financial picture if you used some of your cashed-out equity to consolidate other high-interest debts.
With the funds from your cash-out refinance, you plan to pay off $50,000 in credit card debt with a blended interest rate of 25%, roughly the current average as reported by Forbes. Your minimum monthly credit card payments currently total $1,750.
Even though your mortgage payment increases from $1,389 to $2,212 (an additional $823 per month), you reduce your monthly expenses by $1,750 for a net gain of $927. Here, refinancing at a higher rate could make sense as you greatly improve your overall cash flow.
Example #3: Keeping Your Same Balance While Extending Your Loan Term
Is it possible to lower your monthly payments if you refinance at a higher rate? In some cases, yes.
In this example, you presently have a 15-year mortgage, originally for $300,000, that you took out five years ago at a rate of 3.5%. Your current monthly payments are $2,145 with a remaining loan balance of around $217,000.
However, your financial situation has recently changed, and you need to reduce your monthly expenses. By refinancing into a new 30-year loan at 6.25%, you lower your mortgage payments to $1,336, a monthly savings of $809.
Keep in mind, though, that while this may provide payment relief in the short term, you’ll wind up paying far more in interest costs over the long run.
When Refinancing at a Higher Rate Might Still Make Sense
When does it make sense to refinance at a higher rate? Some scenarios where you might choose to trade in a lower-rate mortgage could include:
- You need to remove a borrower, such as in the case of separation or divorce.
- You want to access your equity to consolidate credit card or other high-interest debts.
- You have an immediate need for a lump sum of cash that takes precedence over higher interest costs and payments.
- You lower your monthly payment by extending your loan term to improve cash flow.
This is situational, though, not universal. While refinancing at a higher rate can sometimes make sense, you may still have other, more preferable options available to help you meet your needs and accomplish your goals.
When It Probably Doesn’t Make Sense
That said, there are some situations where it very rarely makes sense to refinance at a higher interest rate, such as when:
You make a short-term financial decision without weighing the long-term costs and consequences, including the total amount of additional interest paid over the life of the loan.
You borrow against your equity and increase your payments, with no room in your budget or a reasonable plan to cover the new, higher monthly costs.
You’re locked into an ultra-low interest rate with no pressing need for cash, such as considering a cash-out refinance to pay for a vacation or purchase a luxury vehicle.
FAQs About Refinancing at a Higher Rate
Still on the fence about refinancing your mortgage at a higher rate? Here are answers to some of the most frequently asked questions from homeowners.
Does It Ever Make Sense to Refinance at a Higher Rate?
Yes, it can sometimes make sense to refinance at a higher rate depending on your financial goals and life circumstances. For example, you might be able to save money overall by consolidating high-interest credit card debt, or you may have an urgent need for cash with no other practical way to obtain it.
Will Refinancing Always Increase My Payment if Rates Are Higher?
No, refinancing at a higher rate will not always increase your monthly mortgage payment. This can depend greatly on how far you’ve paid down your current mortgage and how you’re structuring your new loan term. If you’ve significantly reduced your principal balance or are extending your repayment schedule, you may see your monthly costs decrease.
Is a Cash-Out Refinance Worth It With Higher Rates?
A cash-out refinance can still be worth it with higher rates, but it all depends on how you use the funds. If you’re consolidating debt or meeting an urgent need for a large lump sum, a cash-out refinance could be a wise decision. However, be sure to compare other types of equity-accessing loans, such as home equity loans and HELOCs, to find the best option for you.
Can I Refinance Again Later if Rates Drop?
Yes, many borrowers refinance their mortgage multiple times while they live in their home. If rates drop in the future, you can refinance again to reduce your interest costs. Keep in mind, however, that some types of loans – such as cash-out refinances and government-backed streamline programs – may require you to wait between 210 and 365 days before refinancing again.
Should I Refinance at a Higher Rate?
Refinancing at a higher interest rate may sound unwise, and in most cases, it is. But there are some scenarios where doing so could be the most practical – or only – option.
You may find it advantageous to refinance out of a lower-rate mortgage if you can reduce your monthly expenses by consolidating other debts. You could also potentially lower your payments and improve cash flow if you’ve reduced your current loan’s balance or reset your repayment term.
Before you decide to refinance at a higher interest rate, be sure to weigh your options carefully and speak with an experienced lender who can help you find the loan product best suited to your unique financial needs.
