Here's Why You Shouldn't Buy a House Based on the Expectation That You Can Refinance

It's been a wild couple of years for the housing market, and whether you were a seller, a buyer, or a mere spectator, chances are you were surprised by what you saw. Unfortunately for wannabe home buyers, the rock-bottom interest rates of 2021 are now behind us, and rates increased from an average of 3.22% for a 30-year fixed-rate mortgage loan in the first week of 2022 to a downright painful 6.42% for the same mortgage by year's end, per Freddie Mac.

As of the week ending May 18, 2023, that rate was sitting at 6.39%, and rates have been stuck in the 6% range so far this year. If you've been saving your down payment and watching the market, hoping for the right opportunity to apply, you might be tired of waiting and just assume it's best to just buy at such a rate and accept higher payments for now, because you can always refinance later. Is this a good idea, though?

Who's to say when rates will drop?

While you might hope you can refinance sooner rather than later, thereby saving yourself years of mortgage payments at 6% interest or more, there's no way to tell when or if mortgage rates actually will fall. And unfortunately, we are still coping with higher inflation (although thankfully lower than during 2022) and corresponding Federal Reserve interest rate hikes. The Federal Reserve doesn't set consumer interest rates, but its actions do have an impact, and borrowing rates are up across the board as a result of the 10 straight rate hikes since March 2022.

No one can say with any certainty where rates are going in the near term. One of the more optimistic predictions comes from the Mortgage Bankers Association, as reported by USA Today, which forecasts a downward trend and an end to 2023 at about 5.2%. That's certainly better than 6.39%, but again -- it's only a prediction.

Will you qualify for a refinance?

Even if rates drop significantly in the near future, will you qualify to refinance your home if you bought at a higher rate? Much like when you got your original mortgage, a refinance lender will need to check your credit score, debt-to-income ratio, and other financial details about you to determine if you qualify, and what rate to give you if you do. You're also generally required to have at least 20% equity in your home, which may not be a problem if you put at least that much down when you bought. But if you made a lower down payment, or your home value has dropped (which can happen), you may not make the cut.

Will you be able to afford to refinance?

Finally, it's important to note that refinancing your mortgage isn't free. You'll also have to pay closing costs for a refinance. These will include such expenses as an application fee, a home appraisal, an inspection, and a flood certification. All told, you could pay in the neighborhood of 2%-6% of the amount you're borrowing in the form of a new mortgage to take the place of the old.

If you're ready to buy a home now and tired of renting, you may decide the time is right, regardless of the interest rate you'll get. But don't make that decision based on an assumption you can just refinance later, especially if you'll be stretching your budget to afford those mortgage payments. As you've just seen, a refinance may not be as easy (or happen as soon) as you're hoping.