Navigating Rising Mortgage Rates

August 13, 2013

Mortgage labyrinthFixed mortgage rates have definitely been rising, and recent forecasts generally indicate they are not going to drop again anytime soon. So is now the time to lock in a low fixed rate, if you haven’t already?

A lot depends on your personal circumstances, of course. But if the weather forecast called for rain, and you were definitely planning to go outside, you would probably carry an umbrella. You also would know there was a chance the forecast might be wrong, but usually a greater likelihood it would be right.

So, if you are set on getting a fixed-rate loan to buy a home, or could benefit from a refinance to lower your rate, odds are this is a good time to do so before rates move any higher. Indeed, as senior financial analyst Richard Barrington pointed out in a recent forecast, this may very well be the last once-in-a-lifetime opportunity.

Mortgage rates are artificially low right now thanks to a Federal Reserve mortgage bond-buying spree that Fed officials have said will end when unemployment improves. But although the popular 30-year fixed rate has spent most of 18 months below 4 percent, Barrington warns: “You don’t want to count on 3.5 percent mortgage rates ever returning. Rates are more likely to move higher rather than lower over the next six to 12 months.”

In his research, Barrington wanted to see “what normal really looks like” once the Fed backs off. And what he found was that by mid-2014, the average rate for a 30-year fixed mortgage could be above 6 percent.

But any discourse on the current state of mortgage rates and what to do about them should start by putting them in their current context. Sure, 4 percent is more than 3 percent, and 5 percent is more than 4. But historically speaking, rates are still low.

That said, it is never a good idea to try to anticipate the ups and downs of mortgage rates. If you are ready to buy or refinance, lock in your rate now. Don’t gamble, especially since your rate lock may allow your rate to float back down if rates recede.

If your speculator instincts take hold, the experts suggest running the numbers every time rates move by a quarter-point or more. In Freddie Mac’s recent national survey of mortgage rates, the 30-year rate jumped by 0.5 percentage point in one week. But that increase was extraordinary.

Next, understand the true cost of rising rates. On a $250,000, 30-year loan, the difference between payments at 4.25 percent and 4.5 percent is a relatively small $37 a month ($1,230 versus $1,267). Rather inconsequential when you are already spending that much money.

But there are other options. One, says Wendy Cutrufelli of the Bank of the West in San Francisco, is to increase your down payment. Perhaps a gift from a family member can help here, or maybe you could borrow from your retirement fund. Hiking your down payment means borrowing less, which could qualify you for a lower rate.

Also consider an adjustable-rate mortgage. Even though ARM rates are lower — and could move even lower in a rising rate environment — Barrington and others warn against an adjustable rate unless you know for certain you can get out of it before the first reset period.

Toward that end, though, Cutrufelli points out that most major institutions offer hybrid ARMs with fixed-rate periods of five and seven years — and sometimes even 10 years — before the first adjustment, which should give most people plenty of time to worry about higher rates later.

ARM rates are 1.5 to 1.75 points lower than 30-year rates, so it should be easier to qualify. But while most 7-1 and 10-1 ARMs are typically qualified at the initial rate, Cutrufelli points out that current Fannie Mae underwriting guidelines call for qualifying borrowers at the current rate plus 2 percentage points.

Another possibility is a 15-year fixed loan. These shorter-term loans are generally priced at 1 point below their 30-year cousins. But even at a lower rate, they are often more costly because they amortize — pay down — over a much shorter period. Still, they’re something to look at.

Finally, consider an interest-only loan. It’s a dangerous choice, to be sure, and one that may not be around much longer under current federal legislation. But it’s certainly a less expensive one, at least at the outset.

This article was originally published in the Chicago Tribune on August 8, 2013.

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