2019 may be the year when 30-year rates cross the 5% barrier and head up from there, at least according to Freddie Mac’s forecast from July 2018. As a result, many people worried about housing affordability, especially with home prices likely continuing to rise.
Considering 30-year rates were in the 3% to 4% universe for the better part of 2011 to 2017, 5% may be a bit jarring. Still, there is actually some good news that comes with higher mortgage rates, and it all starts with a reality check on where rates have been, and where they are headed.
A little history of mortgage rates gives some perspective
It helps to look at where rates have been to get a better idea of just how high they are relative to other times in history. Mortgage rates made history for the better part of the last decade, dropping to levels not seen in more than 40 years.
If you look to the upper left of the graph above, you’ll see that mortgage rates briefly jumped above 18%. That’s right — 18%. So relative to where interest rates have been, 5% is still a historically low rate for home loan financing.
How high are mortgage rates going to go?
Industry analysts, including LendingTree’s Chief Economist Tendayi Kapfidze, project mortgage rates will rise 50 basis points in 2019. (LendingTree is MagnifyMoney’s parent company.)
In terms of actual interest rates, 100 basis points equals 1%. At the beginning of 2018, average rates were about 4%. By the end of this year, rates hit the 5% level (an increase of 100 basis points). If rates go up another 50 basis points, that means we may see 5.5% at some point in 2019.
If you got a 30-year $300,000 mortgage at the beginning of 2018, the 4% rate came with a principal and interest payment of $1,432.25 per month. If rates head to 5.5%, the increase in payment is $271.12 per month for a total principal and interest payment of $1,703.37.
While the monthly payment increase might not necessarily take you off the homebuying trail, the long-term cost comes with a bit of sticker shock: A loan with a 5.5% interest rate versus a 4% interest rate amounts to $97,603.33 of extra interest paid over the life of a mortgage.
Higher rates may be good news in some cases
When interest rates start rising, that’s a sign that the economy is improving. In an improving economy, jobs become more plentiful — you’d have to travel back to the year 2000 to find an unemployment rate as low as it is now. According to the Bureau of Labor Statistics, employment is projected by 11.5 million through 2026 and wages are still going up.
A bigger paycheck means you may finally have the income necessary to purchase a home. Don’t forget your mortgage interest and your property taxes may be tax-deductible. Depending on where your income is headed, you may still realize a potential tax benefit even with higher mortgage rates.
What do higher rates really mean for homebuying?
Higher interest rates always mean higher monthly payments for fixed-rate loans. The higher payment would then affect your debt-to-income ratio, which could impact how much of a house you can buy. Adjustable-rate mortgages become more attractive in high interest rate environments, providing significant savings over periods as long as 10 years.
Higher interest rates also mean less competition when you are trying to buy a house. If the thought of an increase of $100 to $200 per month due to increasing mortgage rates doesn’t bother you, higher interest rates may help weed out the competition, giving you an edge with your offer. On the flip side, you might end up being the one who gets weeded out.
Because there are fewer refinances occurring during periods with higher mortgage rates, lenders start going outside their typical standards for credit approval to provide alternative financing choices. Buyers who have credit histories that don’t fit into the minimum requirements of conventional, FHA, VA or USDA loans are finding more lending options in the form of “non-prime,” “non-QM” and “non-Dodd Frank” programs now being offered.
This increase in alternative lending options means consumers who recently had a bankruptcy or foreclosure have buying options, although the down payment requirements and interest rates will be significantly higher than what’s required of borrowers who meet standard requirements. Self-employed borrowers may be the biggest beneficiaries of alternative credit loans, because some of the program guidelines only require bank statements for qualification. Such a borrower may be more likely to qualify for a mortgage when using their average of deposits over a 12- to 24-month period for qualifying income, instead of tax-return documents.
What do higher rates really mean for refinancing?
Borrowers looking to refinance will see the biggest drawbacks as rates move higher. Monthly savings are going to be less, if any money can be saved at all, with a refinance, especially if your current rate is less than the 5% fixed rates on the horizon — but that doesn’t mean there aren’t other ways that you can refinance and save money.
The current higher interest market has occurred at the same time as increases in home prices. If you put down less than 20% when you bought your home, part of your monthly payment probably includes monthly mortgage insurance. With home prices rising the past four years at very healthy rates in several parts of the country, it may be time to see if you can get rid of your mortgage insurance.
Depending on how much you are currently paying for mortgage insurance, even if the new mortgage rate is more expensive, you still may save money monthly. Get out a copy of your current mortgage statement and then use a mortgage calculator to see where your rate would be based on your current mortgage balance and credit score. You may be surprised by how much you can save if you have 20% equity, even if your new mortgage rate is higher.
You may also find other benefits to refinancing in the current rate and home-value environment, based on how much equity you have. If you are struggling with high-interest credit card balances, or need to do some home improvements you don’t have the cash for, a cash-out refinance may give you some much-needed help.
Higher rates may shift the focus onto affordable housing options
As high home prices and higher interest rates push more buyers out of the homebuying market, lenders begin to focus expanding affordable housing options. One way to provide lower priced homes to the market is to offer competitive financing options for manufactured homes.
Fannie Mae and Freddie Mac launched new mortgage financing programs for manufactured home purchases and construction in 2018, and expect to continue those initiatives into 2019. Lenders are offering loans for the purchase of manufactured homes with lower down payment requirements and easier qualifying standards such as lower credit scores and higher debt-to-income ratios.
Another way to make homes more affordable is to give consumers more options for qualifying. According to a recent Urban Institute study, 53% of renters surveyed indicated that a down payment was an obstacle to homeownership. One solution to this problem may involve using sweat equity instead of cash for a down payment.
The Federal Housing Administration’s definition of sweat equity is “labor performed, or materials furnished by the borrower before closing on the property being purchased.” Freddie Mac recently announced an expansion of the guidelines for its low-down-payment, first-time-homebuyer HomePossible® program, allowing for the entire down payment to come from sweat equity.
This is great news for buyers who have the skills to do repairs and improvements to a fixer-upper, and also for sellers who can’t or don’t want to do the repairs on a property they have for sale.
Homebuyers and homeowners fortunate enough to refinance or buy before 2018 enjoyed some of the lowest mortgage interest rates on record. But those rates were the result of economic turmoil: More people were unemployed, many homes were worth less than the mortgages taken out on them, and retirement and savings accounts were wiped out trying to clean up the excesses of the housing crash of 2007.
Higher mortgage rates are a sign that those days have passed, and have been replaced by an economy that is producing more jobs, higher incomes and more housing wealth. When refinances aren’t taking up the resources of mortgage lenders, more focus can be put on affordable housing, and programs that allow for aspiring and current homeowners with more credit and income challenges to become homeowners.
With rates on the rise, it is important to make your decisions faster with regards to buying or refinancing. Anyone who hesitated from 2018 to 2019 is paying the consequences in the form of a higher monthly payment.