3 Reasons You May Want to Refinance Even Though Mortgage Rates are Above 5%

Interest rates are up, but that doesn't mean refinancing never makes sense.

Refinancing a home loan was very popular during the heart of the pandemic because interest rates fell to recent record lows. But things have changed now, and it now costs much more to secure a refinance loan. In fact, as of July 24, 2022, the average refinance rate on a 30-year fixed-rate loan came in at 5.769%.

With rates well above 5%, many people who obtained a mortgage over the past few years will find that securing a new loan would now cost more than their existing debt. Under those circumstances, refinancing usually does not make sense since the goal is to make loan payoff cheaper. But, even with rates so high, here are three primary reasons why refinancing may sometimes make sense anyway.

1. Your ARM is going to start adjusting

There are two kinds of mortgage loans: Fixed-rate and adjustable-rate loans. Unlike fixed-rate loans, ARMs have rates that are tied to a financial index and they can begin adjusting after an initial startup period. This is where the rate buyers are first offered is locked in. And if you have an ARM, for example, your rate could start moving with the financial index after three years, or five years, or seven years, or 10 years depending on the terms of the loan.

Once your ARM begins adjusting, there's a risk that your rates will go up -- and keep rising over time. If you don't want to face the adjustment of your rate each year, and potentially see your payment go up each time that happens, you may want to refinance if the initial period where your loan was locked in is soon coming to an end.

If you refinance into a fixed-rate loan, the new mortgage you get may be higher than the rate on your ARM currently -- especially now, when rates are above 5%. But it may be better to lock in at today's current rate rather than take the chance of your mortgage getting more expensive every single time it adjusts over the coming years.

2. You need to get cash out of your home

Refinancing could also make sense if you want to tap into the equity in your home so you can get cash out for other things.

You could take a second mortgage or home equity line of credit to get money out of your home. But these kinds of loans tend to come with higher interest rates than a regular mortgage and interest isn't always deductible even if you itemize on your taxes, because it depends on what you use the loan proceeds for.

You may decide that it's better to take a cash-out refinance, which means you get a new loan that is used to repay your current mortgage debt and that gives you extra money as well.

3. You want to remove mortgage insurance

Finally, the last big reason you may want to refinance even at today's current rates is if you need to do so in order to stop paying for mortgage insurance.

Mortgage insurance is required when you make a small down payment on a home. Lenders generally will remove it once your loan balance drops to a set percentage of your home's current value but this doesn't happen in all cases, as some loans -- particularly FHA loans -- require mortgage insurance premiums to be paid for the life of the loan.

If you now have a lot of equity in your home, you may want to consider refinancing so you can opt for a loan that doesn't require you to pay these ongoing mortgage insurance premiums.

In each of these situations, it could make financial sense to secure a new home loan -- even at today's rates. So it's important to remember that a refinance rate above 5% shouldn't necessarily mean it's not worth looking into a new loan at all.