With mortgage interest rates at heights not seen in 14 years, home buyers are seeking strategies to combat those high interest rates when making an offer on a home.
Before we outline those strategies, I want to address something you may be feeling about the idea of buying a home in these market conditions. As I write this in late September 2022, a rapid spike in interest rates caused by inflation has slowed home buyer demand. As a result, the market is shifting somewhat to allow buyers a little more leverage when making an offer on a home. Despite the shift toward a more balanced market, many buyers are sitting on the sideline, trying to look for the right time to enter the market. This leads me to my first point:
Do not try to time the market!
Here’s the thing: no one is able to time the market successfully – not even the so-called experts. You should buy a house when it is the right time for you and you have the resources to do so.
But what about these high-interest rates?
Well, at the risk of repeating the fastest-spreading real estate cliche since “location, location, location,” our advice is for you to “marry the house and date the rate.” That’s right, once you’ve “married” or locked in a price for the home, historically, the only place to go from here is an increase in your equity – at least if you plan to own the house for the next 7 – 10 years. Meanwhile, you should simply “date” your mortgage interest rate and consider that you will likely have the opportunity to refinance at a much lower rate when rates finally come back down in the future.
Of course, there are some strategies we can take to help lower that rate right from the start, so let’s get to it:
Buy Down the Interest Rate Upfront
If you think you will be in your new home for several years, it often pays to buy down the interest rate upfront. Lenders will allow you to provide extra money upfront when you close on the home to buy the rate down from the market rate to a custom rate based on the amount you contribute. This is known as paying “points” toward your mortgage, where a point is equivalent to 1% of the loan’s value. For example, if you have a $300,000 mortgage and you want to pay a point to lower your mortgage rate, you would need an extra $3000 at closing. This is a great option for those that have extra money saved up or who might be able to receive a gift from a family member.
Ask the Seller to Buy Down Your Rate or Contribute Toward Your Closing Costs
Better yet, instead of paying out of pocket to buy down your mortgage rate (see above), why not ask the seller to buy it down for you? This strategy will work in a shifting market when buyers have more leverage. Here’s how it works: You decide to purchase a home and settle on a price of $526,250 (weird price, right? Bear with me, it will help the math work out). You’re putting 5% ($26,250) down and ending up with a loan of $500,000. As part of the contract offer for the home, we ask the seller to contribute $10,000 toward closing, which we could either use to lower our closing costs or use to pay for 2 points to lower your mortgage rate. If the seller agrees, you’ve just saved yourself several hundred dollars a month for the life of the loan.
Lower Your Rate for the First Two Years with a 2/1 Buy Down
If you know you are in line for a promotion or will be in a better position financially in a couple of years, a 2/1 buy-down loan may be right for you. Like the other buy-down scenarios above, a 2/1 buy-down allows you to pay points to buy down the loan’s rate temporarily. For example, on a 6.5% conventional loan with a 2/1 buy down, in the first year, your interest rate will be 2% (i.e., 4.5%) lower in the first year and 1% (i.e., 5.5%) in the second year. In the third year of the loan, the rate will go back up to the original 6.5%, so you’ll need to be prepared for higher monthly payments. This type of loan program allows you to step up into a higher monthly payment when you know growth in your career is on the upswing. This is best done when you’ve negotiated with the seller to pay your upfront closing costs.
Consider an Adjustable Rate Mortgage
While rates were low, adjustable rate mortgages (ARMs) were rare. Now, they are coming back in vogue. ARMs will typically have a period of time where the rate is fixed, but after that time is over, the rate will adjust annually to the prevailing market rate. For example, a 10/1 ARM on a 30-year mortgage will have a fixed monthly payment based on a lower interest rate for the first 10 years and then adjust each year thereafter at market rates for the remaining 20 years. If you believe that mortgage rates will go down during the fixed term (in this case, 10 years), then you will have the opportunity to refinance the loan and never have to “gamble” with the adjusted rates at the end of the 10-year term.
Larger Down Payment
One tried and true strategy that works in any market is to make a larger down payment, which will reduce the risk to the lender and in turn, reduce your interest rate. Of course, you’ll have to have the funds to do this, either from your own savings, a gift from family, or negotiated seller subsidy.
Shorter Fixed Loan Term 20 or 15
Another common strategy for any market is to reduce the loan term. Instead of a 30-year conventional loan, consider going with a 15 or 20-year loan instead. Your interest rate will be lower, but your monthly payments may be higher because the loan is compressed into a shorter time period. Still, if you can afford the monthly payments, you’ll save so much money in interest over the life of the loan.
As you can see, there is no shortage of strategies to help you reduce your costs in a world of higher interest rates. In fact, many of these strategies can be combined for a compounding effect. The key thing is that you don’t have to put your home search on pause if it is the right time for you to move. Armed with the right strategies, you can lower your costs now and refinance when rates come down in the future.
If you would like to speak with a loan advisor that can walk you through a custom scenario, reach out to us here, and we’ll get you connected to the experts.