Interest rates on 30-year fixed-rate mortgages recently increased about 1 percent. When rates begin to rise, home sale activity often picks up. This has happened in many areas of the country as buyers hurry to take advantage of cheap mortgage money before it disappears.
As rates rise, affordability drops. This means that buyers who are only marginally qualified for fixed-rate financing have to consider less expensive mortgage products in order to buy the home they want. Otherwise, they have to buy a less expensive home, or not buy at all.
One problem with buying a less expensive home is it might not suit your long-term needs. It may be smaller than what you ideally need, or located in a less desirable neighborhood, perhaps with an inferior school district. You might feel pressure to move again sooner than you would if you bought the more expensive home. But buying and selling homes frequently is expensive and adds to your overall housing expense.
HOUSE HUNTING TIP: When rates were in the low 5 percent range, most buyers preferred fixed-rate mortgages. Recently, due to rate increases, adjustable rate mortgages (ARMs) have increased in popularity. The interest rate is lower on ARMs, which makes qualifying for a mortgage easier. By switching to an ARM, you may be able to buy the more expensive home that will provide a long-term solution to your housing needs.
However, there are risks with ARMs, particularly for buyers who only barely qualify. As interest rates rise further, so will the monthly payment on an ARM. If your income can’t keep up with the increases in housing expense, you might be forced to sell, perhaps at a time when the market is not as strong as it is today.
Interest-only mortgages, which are becoming increasingly popular, are also risky for buyers who are on a fixed income. Although the initial payments are lower than they’d be on a 30-year, fully amortized fixed-rate mortgage, the monthly payments increase significantly after the initial interest only payment schedule expires.
Many home buyers can only afford a long-term home by using at low interest rate mortgage product. Because there is a rush to buy now, there is a lot of competition that is driving prices higher. If higher rates negatively impact the real estate market and prices drop, the home you buy today could be worth less in a year or two.
However, if you wait to buy, hoping for a price correction, it might not occur and you could end up paying an even higher price. Or, you may find that rates are much higher, which offsets the benefit of a lower price.
Some economic forecasters are predicting that higher interest rates could cause prices to drop as much as 10 percent in some areas. Others believe that incomes will improve with the stronger economy and this will offset the impact of higher rates. Also, in areas where the housing supply is limited, the law of supply and demand could keep home prices up despite higher rates.
To guard against the possibility of a price correction, it’s wise to plan to stay in any home you buy now for at least 5 to 10 years. So make sure the mortgage product you select provides the financial security you need.
If you’re an all cash buyer, or a buyer with a large cash down payment, you should feel no urgency to buy now. You should buy when you find the right house. If that’s not until next year, and rates are higher, you’ll probably benefit from less competition. Prices could also be softer.
THE CLOSING: Higher interest rates will have less of an effect on all cash buyers or those with a large down payment because of the relatively small size of your mortgage.
Dian Hymer is author of “House Hunting, The Take-Along Workbook for Home Buyers” and “Starting Out, The Complete Home Buyer’s Guide,” Chronicle Books.
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