'I Wouldn’t Freak Out Yet.' 6 Tips for Buying a House When Mortgage Rates Are Rising
Just because mortgage rates are on the rise doesn’t mean you can’t buy a home this year. The keys will be knowing your budget, maintaining perspective and having a plan.
Mortgage rates are currently averaging 4.67% — up from just 3.22% at the start of the year, according to Freddie Mac. As a result of rising rates and rising home prices, the typical mortgage payment is now $500 higher than it was at the start of the year.
“If you’re a buyer, don’t get spooked as long as [higher rates are] not putting your financial circumstances in jeopardy,” says Ralph McLaughlin, chief economist at real estate and data analytics firm Kukun.
While today’s rates may be high compared to the sub-3% rates seen in 2020 and 2021, they are still historically low. Between 1971 and December 2020 the rate on a 30-year mortgage averaged close to 8%.
Instead of focusing on how much rates have increased, maybe it’s better to think about today’s rates as less of a very good thing. “I wouldn’t freak out yet,” says McLaughlin.
In fact, once the initial shock wears off, higher rates may eventually be a blessing for homebuyers by cooling down prices and opening some breathing room in a very competitive market.
As with any home-buying decision, the better prepared you are the more likely you’ll achieve your goal. These tips will help you handle rising rates — whether it means going ahead with a home purchase or taking a step back and regrouping.
Don’t try to time the market
Instead of trying to time your home purchase to a specific interest rate, McLaughlin recommends focusing on the non-financial reasons that make it the right time to buy. These can be life events such as marriage, having children or moving closer to aging parents to help with their care. Then work out the financial side of the equation.
Of course, there are economic reasons for buying a home, as the financial benefits accrue over a long period of time. Buying a home at 4.5%, for instance, locks in those monthly payments and are basically hedging against rising rents.
“It’s kind of a good way to lock in what your ‘monthly rent’ would be in the long run,” McLaughlin says.
On the other hand, trying to buy a home for fear of missing out on a lower rate can lead you to stretch beyond what you can comfortably afford. If you’re not financially ready to take on such a large debt, you may soon find yourself struggling to meet other expenses.
“The best thing a buyer can do is maintain a sense of patience and not take on too much risk trying to urgently avoid rising rates,” says Taylor Marr, deputy chief economist for brokerage Redfin.
Look beyond the 30-year fixed-rate mortgage
Buyers should also be aware of the range of financing options available to them, notes Melissa Cohn, regional vice president of William Raveis Mortgage.
For example, initial rates on adjustable-rate mortgages tend to be lower than those on a 30-year fixed-rate loan. Currently, the average rate on a 5/1 ARM is 3.5% — 1.17 percentage points lower than the 30-year average.
ARMs will start with a fixed interest rate for a set number of years. After the fixed-rate period ends, the interest rate will adjust periodically to market conditions. That means it can increase or decrease. ARMs come with a variety of introductory term lengths, with the most common being five, seven or 10 years.
“Locking in for seven or ten years will give the borrower enough rate security to get the next downward [rate] cycle when they can refinance to a fixed rate,” says Cohn.
Of course, there is no guarantee that rates will be lower when your introductory rate expires. However, that may be a risk worth taking if you are reasonably confident that your earnings will go up, your home will increase in value or that you’ll move before your rate becomes adjustable.
Be prepared to adjust your budget — multiple times
When mortgage rates are fairly steady or declining, it may be possible to get a decent read on your spending power months before you actually make an offer on a home. When rates are volatile or rising — like right now— homebuyers need to be more flexible.
As rates plunged below 3%, buyers had the happy circumstance of being able to afford larger and higher-priced homes because the monthly payments were affordable. That is no longer the case. With increasing rates, buying power is reduced.
For example, you are able to afford a monthly mortgage payment of about $2,000. You use a mortgage calculator to determine that with an interest rate of 4.5%, your monthly payment on a $400,000 home will be about $2,026, an amount within reach of your budget.
If weeks later the interest rate has climbed to 5%, your monthly payment has now increased to $2,147, which may be enough to make it difficult for you to afford the payments. Now, instead of being able to look at $400,000 homes, you have to reduce your budget to $375,000 to obtain a $2,013 monthly payment.
When rates are changing as quickly as they are now, you need to keep running the numbers. Keeping in touch with your lender and adjusting your budget accordingly can help avoid sticker shock and disappointment down the road.
Be open to more affordable markets and housing alternatives
Home values have soared over the past two years as the supply of homes on the market is nowhere near enough to satisfy buyer demand. As a result, the average national price for actively listed single-family homes increased to an all-time high of $405,000 this past March, according to Realtor.com.
While overall home prices have grown, some markets and neighborhoods are still relatively affordable, so think of expanding your search area to some areas you may not have originally considered. You can also look at different housing options such as condos or townhomes, says Marr, where prices, although rising, are still more affordable than homes.
Find ways to strengthen your mortgage application
In addition to market trends, the actual rate a lender will offer you will be based on your income, total debts, credit score and other financial factors. One way you can improve your chances of getting a lower rate is by paying off or reducing higher interest debts, such as credit cards.
“This could help boost your credit score relatively and might help improve your rate by a few basis points," says McLaughlin.
Other steps you can take to improve your credit score include paying your bills on time and correcting any mistakes you find on your credit report. The better your score, the more likely it is you’ll find a more favorable mortgage rate.
Wait it out
Avoid the ‘I have to buy now’ mentality, advises Cohn.
At some point, rates may rise high enough that buying no longer makes sense for you. Perhaps monthly payments will rise to a level that you are not willing or able to pay. Or maybe, you’ll find that the combination of high rates and high home prices means you cannot afford a home you’ll be happy with. You can always take a break.
No one knows for sure, but Marr believes that by late summer, higher rates could finally ease competition. Stepping away from the market can also give you time to solidify your financial position, either by saving more for a down payment, improving your credit score or paying off debt.
“You buy a home to be a home — for happiness,” says Cohn. “You want to make sure that you’re financially happy there as well.”
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