One of strongest drivers of demand in today’s housing markets is buyers’ fear that interest rates will rise and that they will never again see rates as low as they are today. That’s one reason the first-time buyer volume of government-guaranteed mortgages, low down payment loans such as FHA and Freddie Mac’s Home Possible Advantage program surged 18 percent in April, according to the American Enterprise Institute.
Buyers who believe this might be the last buying season in which they will see rates below 4 percent are probably right. However, fear of rising rates is motivating some buyers to make foolish decisions, such as overpaying in multi-bid situations or buying a house they don’t love.
With oil prices driving up inflation, it’s a good bet that the Federal Reserve will raise rates again in the coming months. Now is the time to inform buyers that they shouldn’t freak out over modest rate increases — there are bigger factors out there that will affect their access and cost of credit. More importantly, these are issues they can do something about.
Here are five good reasons to be cool about interest rates.
1. Put rate increases in perspective
Rate increases raise monthly mortgage payments but probably a lot less than homebuyers expect. For example, if you are borrowing $250,000 with a 30-year loan at current rates of about 3.8 percent, your monthly payment is $1,164.89.
Should rates rise 0.20 percent to 4 percent — which is what many economists foresee by the end of the year — your monthly payment will be $1193.54, an increase of $28.65.
Paying more is not a good thing, but should rates fall, buyers can always refinance once they have built up some equity. Plus, there’s a little consolation prize: the extra interest they pay is deductible from federal and state taxes.
2. Lower rates with a better credit score
Many buyers don’t realize that borrowers with great credit scores get better rates than those with not-so-great scores. Instead of rushing to buy a home today, it might make more sense to spend some time improving credit scores even if rates rise a little in the interim.
Mortgage rates offered to borrowers by lenders can vary by as much as 1.5 percentage points based on credit scores.
By keeping balances low, paying off cards with small balances, keeping some old debt to establish a positive history, paying bills on time and paying attention to their credit reports, buyers can significantly improve their scores — and lower their prospective mortgage rates — in just a few months.
3. Get the best possible rate by locking it in
When the time comes to apply for a mortgage, timing can be everything — especially if rates are fluctuating. By locking in a rate, lenders are obligated to offer a home loan at an agreed-upon rate regardless of whether mortgage rates have changed between the time of the loan approval and the closing date.
Borrowers typically wait to get a lock-in until they find a home and have an offer accepted. Then they are less likely to lock in too early and miss an opportunity for a better rate before they complete a purchase or get stuck paying extra to extend the lock once it expires.
4. Take some time to get a better deal
It stands to reason that the more time you give yourself to find a house that fulfills your list of must-haves, the more likely it is you will get a better deal. You will see more listings, and their prices might fall over time.
As buyers house hunt, they might change their minds about what they want in a home. When buyers see a house they like, they should use time as a weapon in negotiations. Sellers usually have shorter timeframes than buyers.
Homebuyers will probably save much more by smart negotiating even if they have to pay a little more in interest.
5. Stay cool
Don’t let the obsession with getting a low rate cause homebuyers to do something foolish like get into a bidding war, pay too much because of timeline pressure or settling for a house they don’t really like.
If buyers allow themselves to get frustrated with house hunting, they can find themselves making a bad decision that they have to live with for years.
Preparation makes all the difference. When buyers expect to encounter stressful situations, they are less likely to make mistakes. A healthy attitude toward interest rates helps them stay focused on their maximum price ceiling and the most important feature they want in a home.
By taking the time to find the right deal they might pay a few more dollars in interest each month, but they will be much happier for years to come.
Steve Cook is editor and co-publisher of Real Estate Economy Watch. Visit him on LinkedIn and Facebook.