In the 2nd quarter of 2017, the Federal Reserve has raised interest rates twice, with the intention of making additional adjustments before the year ends. Rate increases from the Federal Reserve could potentially push mortgage rates to decade level highs in the near future. Here is what you need to know if you plan to purchase a home in a rising rate environment.
What Factors Impact Mortgage Rates
The Federal Reserve controls the overnight rate, which banks charge each other for very short lending needs. This control has a corresponding impact on the Prime Rate, which moves in direct correlation to the Fed Funds Rate. When the Federal Reserve increases the Fed Funds rate by 0.25%, the Prime Rate rises by 0.25%.
Mortgage rates are long-term and not directly connected to the Federal Reserve rate changes. However, when interest rates move upward, mortgage rates typically follow quickly. Long term rates, like mortgages, use the 10-year Treasury as a benchmark for rates rather than Prime. Other factors banks consider include supply and demand, market competition, and the long-term horizon for interest rates. When banks lock in a rate for 30 years, they, not the consumer, take the risk of rising rates. As a result, mortgage rates can sharply rise even when Prime remains the same. For example, after the election in November rates jumped nearly half a point overnight, despite the lack of any movement in the short-term rates. The markets responded with the anticipation of an improving economy due to government investments in infrastructure and the promise of corporate tax cuts.
With rates set to rise steadily over the next few years, there are things you can do to ensure you get the best deal on your next mortgage.
The Best Moves You Can Make to Secure the Best Mortgage
- Do not put off buying. With rates expected to continue their climb, buying now will lock in lower rates for the long term. The good news is that higher rates tend to lower demand, which could result in banks easing requirements for loan approvals to steady mortgage volume.
- Lock in your rate for 60 days. It frequently takes more than 30 days to close a loan and paying a few extra dollars to lock in a rate for the 60-day period will secure the rate until closing. When you max out your borrowing capability, a small rate increase could lead to higher down payment requirements or lower approval amounts.
- Don’t automatically choose the 30-year fixed rate option. A 15-year mortgage has a lower rate and a payment ranging between 30% and 50% more, even though you cut the repayment time in half. You also save a significant amount of interest payments. Choosing a 20-year loan does not typically offer a break in the interest. A calculator can help you determine the level of savings.
ARM or adjustable rate mortgages might also be a wise choice if you have a shorter time horizon. They offer discounted rates of as much as 1% lower than a 30-year fixed rate. ARM loan gives you a 30-year repayment, keeping the interest and payments low. The downside is the risk of rising rates, could leave you with a much higher payment when the rate adjusts at the end of 5 or 7 years.
- Compare terms and rates across loan programs. Low down payment mortgage options come from both FHA and private bank programs. When comparing across lenders check different programs and terms in addition to the rate. You might find a slightly higher rate in a program that is a better fit for your needs, such as lower down payment, assets, and other lending parameters. The rate may not be the deciding factor.
- Your credit score isn’t the only important factor. Mortgages are less credit score driven than most loans because the bank evaluates every aspect of your financial life. Lenders look for residence and job stability, total assets, down payment, and stable or rising income. Credit is just one piece of the puzzle, allowing buyers with low 600 scores to purchase a home as long as other factors fall in line.
- Keep the total loan balance under conforming limits. Banks charge lower interest on conforming loans because they can sell them to loan buyers. That amount varies based on location, but often falls around $417,000. Loans above this amount could result in a significant rate hike. Increasing your down payment or lowering the price of the home can prevent paying an interest premium for your new home.
- Buy down points or pay an origination fee. Buyers often ask for a rate based on no origination or points to get the lowest down payment. Paying points or an origination fee will lower the interest rate. While the price of buying down the rate changes, if you will remain in the home over the long term, you might end up ahead by paying extra up front to get a lower rate.
- Pay attention to mortgage insurance. Loans with less than 20% down typically require mortgage insurance, which raises closing costs and the monthly payment. Some PMI insurance ends when you reach 20% equity in the home, while others remain on the loan until you pay it off or refinance, which could make the ARM loan more attractive.
When you provide a strong loan application, you increase the number of loan programs you qualify. Solid credit with explanations of any derogatory marks is just the beginning. Having an adequate down payment, enough for closing costs and cash reserves can lead to more loan options, a better rate, and ultimately a better loan. With mortgages, there are many factors outside of credit, which will determine both the rate and terms you can secure on your new mortgage.