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How to Buy a Home When Mortgage Rates Are Rising

Home Affordability, Mortgages
How to Buy a Home When Mortgage Rates Are Rising
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Mortgage rates have risen about half a percentage point since September. What does that mean for you if you’re buying a home now or plan to buy one soon?

For starters, don’t panic.

When you’re buying a home, the mortgage rate matters, but it shouldn’t monopolize your attention, says Robert Frick, corporate economist for Navy Federal Credit Union. “You shouldn’t focus on the rate and let that scare you into making a hasty decision about buying a house,” he says.

How rising rates affect your monthly payment

The average rate on the 30-year fixed-rate mortgage rose to 4.54% on Feb. 16, 2018, according to NerdWallet’s daily rate survey. It averaged 3.99% on Sept. 26, 2017 — meaning it has gone up more than half a percentage point in less than five months.

While a half-point increase doesn’t have a major impact on the monthly payment, the added cost does add up over time. On a 30-year loan for $200,000, the monthly payment would be nearly $59 more at a 4.5% interest rate than at a 4% interest rate. That adds up to more than $21,000 over 30 years.

What to do when rates rise

Mortgage rate fluctuations have been catching home buyers off guard for generations. Your forebears have developed tried-and-true strategies to cope with rising rates. Here are some things you can do when mortgage rates trend higher:

No. 1: Lock your mortgage rate. With a mortgage rate lock, the lender promises a defined combo of interest rate and points. If you close the home loan by the specified date, the rate can’t go up. You can use this tactic after the lender has approved you for a mortgage for a specific house. Some lenders offer a one-time “float down” option allowing you to secure a lower interest rate if rates go down; this option is more common for construction loans and long-term rate locks.

No. 2: Buy “points” to reduce the interest rate. If you have the cash, you can pay for discount points in effect, prepaying some of the interest in exchange for a lower mortgage rate. One point equals 1% of the loan amount. The discount you get for one point varies as mortgage rates fluctuate. But as a rule of thumb, paying one point often gives a rate cut of one-quarter of a percentage point.

No. 3: Revise your price range. A higher mortgage rate brings higher monthly payments. When you begin your home search, determine a range of interest rates that will still allow you to afford the type of home you want without stretching your budget past the point of reason. Or, rising rates might force you to adjust your home-price range downward. Start with NerdWallet’s loan affordability calculator and enter in different mortgage rates to see how the numbers change.

Why rates are rising now

This recent rise in mortgage rates arrived in two stages:

  • The first happened in the weeks after the passage of tax reform in late December
  • The second happened Feb. 2, 2018, when the January employment report indicated that hourly wages had risen 2.9% compared with 12 months before

The tax cuts and the wage report were both regarded as inflationary, because when people have more money in their pockets, they tend to spend it, driving up prices. (Classic supply and demand.) And higher inflation tends to bring higher interest rates for everything, including mortgages.

On top of that, futures traders expect the Federal Reserve to raise short-term interest rates at least two, if not three, times this year, which could exert upward pressure on long-term mortgage rates.

Frick says businesses and governments around the world are ramping up their borrowing. As they compete with one another to borrow money, they bid up interest rates. This upward pressure trickles down to consumers, who end up paying higher interest rates for everything from credit cards to mortgages.

Are higher rates the ‘new normal’?

Talk to any housing economist about mortgage rates, and you’ll hear that rates have been abnormally low in the decade since the housing crash.

“I remember in the mid-’90s, getting a 7% rate, being happy with that,” says Dean Baker, senior economist and co-founder of the Center for Economic and Policy Research. “The rates we’re looking at today are still, by any measure, pretty low. So it’s basically the economy getting back closer to normal.”

Frick says: “People have gotten kind of lulled into these low rates, and a lot of people think this is normal, but this is not normal. We’re returning to normal, and that’s still going to be a painful process because we’ve gotten used to low rates.”

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