How To Shop for a Home with Rising Interest Rates
High mortgage rates usually result in high monthly payments paid over the course of a loan. You will also incur a large amount of interest when repaying the mortgage.
Rates tend to rise when the national economy tries to rebound. You have to prepare your financial situation to cope with the changes as this happens. It all comes down to your debt-to-income ratio, credit score, and the amount of down payment you can afford.
In a market with high-interest rates, mortgage lenders are difficult to please. What if there was a way to turn your situation around and find your dream home in these market conditions? Read on to find out how this is possible.
Improve Your Credit
You can only secure a low mortgage rate if you qualify for it. Knowing whether you qualify for the rate is by checking and improving your credit score. A good credit score reduces the risk to a mortgage lender, allowing them to serve you favorable rates.
Your credit score is based on payment history, debt levels, and credit history length. It is also determined by new credit and the types of credit used.
Most credit scales fall between 300 and 850, with 670 to 700 being considered a perfect score. Mortgage lenders use these scores to determine your borrowing risk when you want a home loan.
Review your credit report every year as you try to improve your credit. Credit bureaus like TransUnion, Experian, and Equifax can help you with this task. It would be best to also dispute any errors on your credit reports to the Federal Trade Commission.
Paying down your credit balances and making timely payments can also boost your credit. Always maintain a debt utilization ratio below 30 percent for favorable mortgage rates. Your balance-to-limit ratio should also be lower for the same effect.
Choose a More Affordable Property or Sublet the Property
When looking for an affordable home, one factor is the debt-to-income ratio. It's essential to buy a home you can afford to reduce your debt obligations. As a rule of thumb, don't spend more than a quarter of a dollar of your income on the purchase when signing the loan agreement.
Though most homebuyers overlook it, an online homebuyer education course can prepare you for a house purchase. The course will take you through the finance terms used in the housing and mortgage market. Most lenders and banks make it mandatory to sign up for federally-certified online courses (which cost between $75 and $100) before taking a loan.
Renting out part of your home can help you spare finances for your mortgage payments. However, you have to review the local, state, and federal laws on subletting to be compliant. Remember to review your current lease agreement to determine whether it allows subleasing.
Set up the space you would like to rent once you have the green light from insurance and legal requirements. If the lease legally allows you to rent part of the home, check whether the same is allowed by your homeowners' insurance policy. You should also price the unit based on the local rental rates.
The sublet property will only be available to prospective tenants once you list it online. Perform background checks on potential tenants and secure your valuables before letting them in your house. You should also define boundaries, sign a lease, and claim your taxes' rental income/expenses.
Buy Mortgage Points
Buying mortgage points can help you lower the interest rates on your home loan. Mortgage points are fees paid to a lender to reduce the interest rates on your mortgage.
You will be buying down the rate with these points, with each point bought costing 1 percent of the home loan amount. For instance, it'll cost you $4,000 to buy one point on a mortgage of $400,000.
Each point bought will lower your home loan rate by up to 0.25 percent. So, if your mortgage rate is 4 percent, buying one point will make the rate amount to 3.75 percent throughout the loan. Note that the rate-reducing power of the points depends on the lender, type of home loan, and interest rate market.
Expect to pay mortgage points at closing since they will be included in your loan estimate document. You can benefit from the points if you intend to pay for the loan for a more extended period. Dividing your buydown costs by the potential monthly savings can help you determine whether the points suit your situation.
Enlist a Mortgage Broker
A mortgage broker acts as a link to a mortgage lender when shopping for a home. They can help you secure the best home loan for your unique situation and needs. Mortgage brokers determine the best lender for your situation and whether your loan of choice matches a particular lender.
Your mortgage broker will collaborate with everyone involved in the loan process, from the underwriter to the closing agent and real estate agent. They can work with a brokerage firm or independently pull your credit reports, review your income/expenses and oversee the loan paperwork. Most of them have access to more advanced mortgage-pricing systems, which speed up and streamline the lending process.
You get to save on application fees, appraisal fees, and origination fees once the broker convinces your lender to waive them. The loan process will take a shorter time since your rates and the loan amount will be negotiated by a third party.
Brokers earn their fees through commissions paid by mortgage lenders or fees paid by borrowers. Though these earnings vary, most take about 2.75 percent of the loan amount.
Make Lenders Compete for Your Loan
Since mortgage lenders have different loan products and interest rates, shop around to secure a favorable financing deal. With the rising rates, the number of people financing homes with mortgages has also decreased significantly. Lenders are more than ever eager to compete for borrowers' loans.
Get quotes from more than three lenders (including portfolio lenders, online lenders, credit unions, and savings and loan institutions). Compare each offer and consider one that comes with appealing rates and terms. Use the current interest rate dynamics to negotiate a lower rate and closing costs.
Since mortgage rates change daily, there's no guarantee of a fair deal until the lender locks your rate. It's thus essential to review the monthly payments, loan terms, loan types, rates, and closing costs on each quote. Present your best offer to a lender of your choice and see whether they can beat or match it.
You can call or email the lender with your loan offer to get their attention. If they fail to beat or match your best offer, inquire whether they can lower fees such as underwriting and origination fees. If the process proves unsuccessful, start seeking written quotes and loan estimates from new lenders and repeat the entire process.
Choose a Short-Term Loan
Short-term mortgages take less than ten years to mature and have relatively lower interest rates. However, they require you to pay high monthly payments spread over a short time frame. You can count on them to build equity in your home faster and attain homeownership status.
Like other mortgages, short-term home loans require you to make monthly payments for the principal balance and loan interest. They are an ideal option if you can afford to pay hefty monthly mortgage payments. The lender will determine the loan's interest rates by considering any inflation that will affect the loan over time.
Calculate your monthly expenses before considering a short-term mortgage. Most short-term home loans come with shorter terms of up to 15 years with interest rates between 0.5 and 0.75 percent. You should also review your debt-to-income ratio to determine whether the future monthly payments will be affordable.
Short-term home loans are riskier to lenders due to the high monthly payments. They come with stricter eligibility requirements to offset the risks. Common types include short-term interest-only, short-term fixed-rate, short-term tracker, and short-term offset mortgages.
With a short-term interest-only mortgage, you will only pay back the interest on the principal amount. The amount won't be due until the end of your loan term. On the other hand, a short-term fixed-rate mortgage allows you to have an interest rate fixed for a particular period.
Short-term tracker mortgages stick to a particular mortgage rate, which is bound to fluctuate. You may consider a short-term offset mortgage to reduce the interest with your savings.
Opt for a Different Loan Product
Provided you qualify for the right loan type, it's easier to get a low-interest rate. The mortgage lender may require little to no down payment on the loan. Loan products with favorable deals include USDA, VA, FHA, and conforming loans.
If your current mortgage options don't offer favorable deals, opt for a different loan product that suits your borrowing profile. Find one that doesn't require you to have a lot of money saved for a down payment. It should also enable you to build equity faster in becoming a homeowner.
One thing to note is that most zero- and low-down-payment mortgages attract hidden charges. Identify these expenses before signing up for the loan.
If you consider an FHA-backed loan, your credit score should be at least 580. For scores between 500 and 579, the lender will need a 10 percent down payment. The good thing about this loan is that it qualifies you for a 3.5 percent payment.
Conventional loan products like Home Possible and HomeReady may suit you if you're in the low-income bracket. You may turn to conventional loans with low-down-payment incentives. However, lenders will require a credit score of at least 620 to qualify you for the loan.
Your military connections (if you have any) can help you get a VA loan. VA loans' credit score requirements vary with the lender, with most lenders requiring a 620 score. You also have to meet other eligibility requirements to enjoy the low-interest benefits of VA-backed home loans.
USDA-sponsored loans may be ideal for buying a home in rural or partly rural areas. A credit score of 640 and above will be needed for this type of financing. If your credit score is low, the lender will take you through a more thorough underwriting process to reduce the loan processing risks.
Turn to an Adjustable-Rate Mortgage
You can turn to a home loan with varied interest rates to afford your dream home. Adjustable-rate mortgages (ARMs) come with rates and monthly payments that change periodically.
With their unpredictable rates, ARMs may suit your situation if you don't intend to stay in the financed home for a long time. The initial rate is usually lower compared to that of a fixed-rate home loan. However, monthly payments and interest rates can go higher or lower after this period ends.
You get to enjoy lower interest rates in the first years of the home loan and save on the monthly payments. ARMs tend to be risky for borrowers planning to stay in a financed property for decades. It may be wise to refinance your home in the future if you've signed up for this type of loan.
Standard adjustable-rate mortgages include hybrid ARM, interest-only ARM, and payment-option ARM. With a hybrid ARM, the loan term begins with a fixed rate for a short while and then goes up or down on a given schedule.
Interest-only ARMs allow you to pay interest without the principal amount for a specified period. During this period, your monthly mortgage obligations will be low, and it will be difficult to build equity unless the home's value appreciates. You'll resume making both interest and principal payments at the end of this period.
A payment-option ARM will suit you if you want to set your payment schedule and structure. However, the minimum monthly payment will depend on the initial rate of the mortgage. The downside of this option is that your lender may require you to make larger monthly payments if the principal balance increases above the required limit.
Make a Large Down Payment
Mortgage lenders will consider you a less risky borrower when you make a sizeable down payment. They are even willing to lower the interest rate and monthly payment throughout the loan. A 20 percent down payment is considered sizable enough for one to get better rates.
The down payment you make is critical when lenders determine your loan-to-value ratio (LTV ratio), the loan amount divided by the property's fair market value. A larger down payment can lower your LTV ratio and qualify you for lower interest rates. When pricing the mortgage, lenders also consider your LTV ratio to cover their risk of lending you finances.
A large-down-payment loan entitles you to zero private mortgage insurance (PMI) premiums. PMI premiums help protect lenders if borrowers fail to repay the loan on the agreed time. Most lenders offer appraisal waivers to borrowers who put at least 10 percent down when signing up for a home loan.
You may qualify for smaller monthly payments if you make a sizeable down payment. The low mortgage obligations will save you money in the long run. Lenders consider large down payments as an incentive for borrowers looking for favorable loan terms.
A large down payment increases your chances of getting multiple offers on your dream home. That's because sellers usually consider buyers who are better positioned to qualify for a home loan.
The Bottom Line
While you may expect the best outcomes in the home buying process, many factors (like mortgage rates) may be out of your control. However, sticking to the tips discussed in this guide can make the process easier. You should also stay updated with the mortgage market trends and understand your obligations.
Rising mortgage rates aren't expected to change anytime soon. Instead of giving up, know your loan options, compare rates across different lenders and make lenders compete for your loan. Good luck shopping for a home with the current market conditions.