How to Buy a Home When Interest Rates Are Rising

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Just as home prices have been steadily increasing, so have mortgage interest rates. The average rate for a 30-year fixed-rate mortgage was 4.81% on Nov. 29, 2018, according to the data from government-sponsored enterprise Freddie Mac's Primary Mortgage Market Survey. The rate was 3.9% during the same week in 2017.

For 15-year fixed-rate mortgages, the average rate jumped to 4.25% from 3.3% a year ago, and 5/1 adjustable-rate mortgages increased from 3.32% to 4.12% year-over-year.

How Mortgage Rates Impact Affordability

Though rates were still lower than their pre-recession levels, some homebuyers were at risk of being pushed out of the market.

The typical homebuyer lost nearly $30,000 in purchasing power at the beginning of 2018 due to rising mortgage rates, according to a report from real estate brokerage Redfin.

Mortgage rates can make or break a home's affordability. Using a hypothetical example, let's say a potential homebuyer wanted to purchase a home around this time in 2017. For a $200,000 30-year fixed-rate loan with a 20% down payment and an interest rate of 3.9%, the estimated monthly payment would have been $1,132, according to The Balance's Mortgage Calculator.

Fast-forward to 2018, that same $200K loan with a 4.81% interest rate would have an estimated monthly payment of $1,217. That's an increase of $85 each month.

Rising Rates Will Continue

The Federal Reserve has the power to raise or lower the federal funds rate. For example, in 2017, the federal fund rates rose three times, 0.25% each time. In December 2018, the Federal Reserve announced plans to raise the federal funds rate for the fourth time that year, also at 0.25%.

Mortgage rates are indirectly affected by the federal funds rate and usually rise when it does. The 30-year fixed-rate mortgage was predicted to rise to an average of 5.1% in 2019 and 5.6% in 2020, according to a November 2018 forecasting report from Freddie Mac. However, no one could have predicted COVID-19 and the effect it had on the economy. Instead of the rates predicted, the 30-year fixed-rate mortgage for July 1, 2021 was 2.98%.

Buying a Home When Rates Are Rising

How can you still make your way into the housing market in a rising-interest-rate environment? Below we highlight a few options:

  • Boost your creditworthiness. Sure, your credit score might already be above 700, but there's always room for improvement. Chip away at your debt load to lower your debt-to-income ratio, review your credit reports for any lingering blemishes or errors that can be removed, and consider increasing your down payment amount. Borrowers with FICO scores in the 700-759 range may see an average mortgage rate of 2.798% for a 30-year loan for $200,000 while those with scores of 760 or higher might expect an average rate of 2.576%. That's barely a $20 difference in the monthly payment but it adds up to thousands of dollars saved over the life of the loan.
  • Lock your mortgage rate when it makes sense. If the interest rate your lender is offering is attractive to you at the moment, consider locking it in. That way you won't have to concern yourself when rates continue to tick up. Keep in mind, a mortgage rate lock works best when you're closing on your home in the very near future — rate locks typically last for 30, 45, or 60 days.
  • Pay mortgage points at closing. Mortgage points, also known as "discount points" are fees you pay to help you get a lower interest rate on your loan. One mortgage point is equal to 1% of your loan amount, so on a $200,000 mortgage, one point would cost $2,000. Another advantage of mortgage points is that they might be tax-deductible. If you're already eligible to deduct the interest you paid on your mortgage, then you might be able to deduct the points paid on the mortgage as well.

It's also important to keep in mind that your interest rate is just one component of your mortgage. There are other factors to consider, such as the type of mortgage you're borrowing and even the lender you choose. The most effective way to get a competitive interest rate is to shop around and compare loan estimates.

Additionally, you might be able to take advantage of a mortgage refinance if rates improve not long after you get a mortgage. 

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