Interest rates are rising. It may be tempting to think that a fraction of a point isn’t much. But even a small increase can add up to tens of thousands of dollars over the life of a loan. Ultimately rate increases affect what home a buyer can afford and what a seller can ask. As prices of homes have increased over the last seven years, buyers in many situations have realized that they need to settle for a lesser home than desired or stay put for longer. Here are a few things to keep in mind when considering interest rates.
Fractional Rate Increases Add Up
If the current rate of 4.65% for a 30-year fixed loan increases by just one point, how much more would you owe? Assuming the home is about $300,000 with a 20% down payment, the monthly mortgage would increase by $147 per month or $53,000 over the life of the loan. What if the increase is much smaller, like 0.2%? That’s still a $10,400 increase over thirty years.
Economists at Freddie Mac estimate that interest rates could rise to 5.5 and 6% levels within the next two years. The last time rates reached 5% was 2011. And to keep things in perspective, we’re still a far cry from the peak interest rate of 1981, which was 18.63%! But while rates are still relatively low, they do affect what people can afford. Mortgage loan officers have reported that many buyers settle for a home in a lower price range, a further away location, or a fixer upper. And some put off changing homes all together.
What Buyers Can Do
Shopping for a low mortgage rate is like any other shopping for the best deal. Look for specials and comparison shop among banks and credit unions. Lending institutions often present specials to lure in home buyers. Also, some institutions have consistently lower rates. Another opportunity buyers can take advantage of are lock-in rates. This allows a buyer to become pre-approved at a particular “locked” rate in case rates increase during their home search process. Watch out for banks that charge to lock in the rate. Also, be forewarned that sometimes rates do fall and you’d still be on the hook for the locked rate.
Are ARMs a Good Path to Affordability?
Adjustable Rate Mortgages, known as ARMs, are loans that typically start at a lower than average interest rate for a set period of time (usually several years). After that introductory period, the rate increases. Indeed, ARMs were one of the main causes of the housing crash a decade ago, but fortunately some consumer protections have been put in place since then and restrictions on who qualifies are tougher than pre-recession times. Most of today’s ARMs cap the amount in which the rate can increase. Still, this can be a risky option if the higher rate becomes unaffordable. And counting on the ability to refinance at a lower rate may be a losing strategy if interest rates continue to rise.
Be Decisive
If you come across a mortgage rate that works for your situation, don’t delay too long. Rates are increasing, so what you can afford today may be stretched thinner a few months from now.