Your dream of a white picket fence doesn’t have to turn into a nightmare, just because of the bond market.
Consumers hoping to buy a new home or refinance an existing mortgage are gnashing their teeth as mortgage rates climb higher and higher. The national average 30-year fixed-rate mortgage recently stood at 8.26 percent, according to HSH Associates of Butler, N.J., which collects data from lenders around the country. Rates are close to their highest levels since September 1996, although they briefly touched 8.30 percent in August of last year. A year ago, mortgage rates were 6.90 percent.
Shudders in the bond market are to blame: the monthly employment report for December, released on Jan. 7, demonstrated that the economy is super-strong.
The Federal Reserve is likely to raise interest rates early next month to head off inflation. More rate increases could follow, further slowing the pace of home buying and refinancings. The expectation about the Fed has caused Treasury bond yields to soar; of course, mortgage rates have followed.
The jump in rates is already hitting home buyers in the wallet. On a $200,000, 8.25 percent mortgage, a homeowner now is paying monthly principal and interest payments of $1,503, or $139 a month more than a 7.25 percent mortgage.
Over 30 years that adds up to about $50,000 in additional payments. Rising rates have put a dent in the refinance market–refinances now make up 25 percent of all mortgage originations, down from about 55 percent a year ago.
So what’s a house hunter to do? Don’t despair: Experts say a bunch of creative options are available.
Adjustable-rate mortgages, or ARMs, look attractive, according to experts. After an introductory period, these loans “adjust” up or down periodically, usually in line with changes to an index that tracks the Treasurys market. The big benefit: You can temporarily lock in a low interest rate.
A traditional, one-year ARM currently sports an interest rate of 6.62 percent. After the year, your rate is based on one-year Treasurys plus 2.75 percentage points, or about 8.75 percent in today’s market, a bit higher than current fixed-rate mortgages. There are usually limits on how the rate can be adjusted, however, helping borrowers.
Consider the savings on a $130,000 mortgage. A borrower who takes out a 30-year fixed-rate loan at today’s rates would pay $1,005 a month in principal and interest. By contrast, a borrower who takes out a one-year ARM at 6.6 percent would pay $862 a month during the first year, a savings of $1,716.
“ARMs are clearly good if you don’t expect to be in the house for long,” says David Berson, Fannie Mae’s chief economist. “Or, they may be a good choice if you expect to refinance later.”
So-called hybrid mortgages offer a fixed rate for a specified time, such as five years, and an adjustable rate thereafter. If rates fall, you can refinance. Even if they don’t, such a loan makes sense for borrowers who expect to move to a new home before the end of the initial fixed-rate period.
Keith T. Gumbinger, an analyst at HSH, suggests a “2-1” buydown. With such a mortgage you can get an interest rate about two percentage points below the market rate for the first year. The rate increases by one percentage point in the second year, and rises again by one percentage point a final time.
Instead of paying 8.25 percent today, you get 6.50 percent in the first year, 7.50 percent in year two and 8.50 percent for the remainder of the loan.
Borrowers are warming up to ARMs. About 30 percent of all new mortgage applications are ARMs, according to Freddie Mac, compared with about 13 percent a year ago. Even President Clinton and Hillary Rodham Clinton chose a hybrid ARM to finance their new $1.7 million home in New York.
“A year ago maybe 5 percent of my business was something other than a fixed-rate loan,” says Scott Norman, president of Westar Mortgage in Austin, Texas. “Now I’m looking at probably 75 percent of my business is some sort of ARM.”
Just remember: The rate on an ARM is adjusted upward at some point, and in some cases borrowers could find themselves paying more than they would have had they taken out a basic 30-year fixed-rate loan.
Some people “have a visceral distaste for a rate that changes on them,” Berson says.
Borrowing costs can be cut drastically by boosting an initial down payment. An extra $5,000 up front can enable a home buyer with a $100,000 mortgage to achieve the same monthly payment with an 8 percent mortgage as he or she would pay on a 7.5 percent mortgage.
For consumers flush with stock gains or from the sale of a previous home, it makes sense to plunk down some more money up front, especially if you expect to stay in your home for a while.
You can also pay additional points, or percentage points of the loan’s amount, to lower the interest rate. Each point should lower your interest rate by between .125 and .25 percentage point, experts say.
Rates may be going up, but competition within the mortgage industry is fierce because so many new players have jumped into the business amid the recent housing boom. Savvy borrowers can play lenders and brokers off each other, and scour the industry for the cheapest rate.
Borrowers may even be able to secure a promise from a lender of a lower rate, if rates begin to fall. Some in the industry report that some mortgage companies are starting to offer rates that fall below the prevailing national interest rate. As lenders see their activity slow, as rates rise, many will resort to aggressive discounting, experts say.
If you’re worried that rates will keep rising, you may be able to persuade a lender to process loans with a shorter commitment period, such as 30 days instead of 45 days or 60 days.
But be careful: If a rate looks too good to be true, it just may be. In an age of cutthroat competition and Internet startups it is easier than ever to get a rate quote. But they often come with hefty, hidden fees attached.
Rates could very well start slipping later this year, perhaps by the spring, once the Fed has boosted interest rates enough to slow the economy, analysts say.
But don’t become a rate timer. Remember that even at 8 percent mortgage rates are about 5 percent after taxes. And with real estate rising by at least that much in many locations, waiting may cost you more than you think.
Keep in mind that rates are still attractive from a historical perspective. Ten years ago, the national average for a 30-year fixed-rate mortgage was 10 percent, according to HSH.
“In the scheme of the mortgage environment of the last 10 years, rates are still low and still attractive,” says Jim Dougherty, director of customer service, Greenpoint Mortgage Corp.
