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Buying a home became more expensive this year but the good news is not by much. Mortgage rates are on the rise, with 30-year fixed mortgages consistently above 4% in 2018 but rates remain at record lows. A decade ago, rates were consistently above 6% and well into the double digits in the 80s and early 90s.
“While rates are certainly going up, the impact to the borrowers is not as drastic as some may think,” said David Gorman, a division executive with Bank of America. “It’s a pretty emotional topic. People hear rates are going up and they jump pretty quickly, but it’s not as aggressive as many would make it sound.”
Although higher rates signal a tighter market for both homebuyers and sellers, it’s important to understand the context in which they’re happening and how you can maximize your opportunities even if rates continue to rise.
Why mortgage rates are changing
It’s not the Fed’s fault. The Federal Reserve raised its benchmark interest rate earlier this year, a move that consumers sometimes associated with changes in mortgage rates. However, the Fed rate has less influence on fixed-year mortgages than you might think.
For one thing, the Federal Reserve doesn’t set mortgage rates so it doesn’t have a direct impact on the terms of your potential home loan. Jace Stirling, mortgage divisional manager at SunTrust, explained that the federal funds rate, which is the average rate at which financial institutions lend to one another, “is really, really short term” and isn’t necessarily an indicator of what’s going to happen with long-term mortgage rates.
The Federal Reserve benchmark rate primarily affects loans and lines of credit influenced by the prime rate. This means that adjustable-rate mortgages that are approaching reset and home equity loans and lines of credit are susceptible to fluctuations along with the Federal Reserve.
Keep your eye on the 10-year Treasury note. When it comes to long-term fixed mortgages, it’s the 10-year Treasury note you want to watch. This note represents the expected long-term Treasury yield, and it influences not only the Federal funds rate but interest rates on a number of financial products, mortgages included. The Federal funds rate can influence Treasury yields, but it does not directly impact it, according to Pete Boomer, head of mortgage protection for PNC Bank. There have been instances of “flatter or inverted yield curves,” he said. “So while it generally has an influence, they are not specifically tied together.”
Boomer added that similarly, the 10-year Treasury note and mortgage rates “are not tied together, but they do have a close correlation.”
So far in 2018, increases in the Treasury yield rate have influenced the mortgage market this year. “As the 10-year moves up, so will your long-term interest rates,” Stirling said.
Stirling added that the other factor that is currently influencing the cost of homebuying is low real estate inventory, which is driving up valuations for available properties.
How rising rates impact homebuyers
The prospect of higher interest rates motivates some buyers to become more aggressive in their home searches. Gorman said that people who have been considering purchasing a home but have been on the fence may take a more proactive approach in higher rate environments.
“When they hear that rates are going up, they’ll jump in feet first and they’ll start to look to move,” he said.
The impulse to act quickly makes sense, especially since higher monthly payments aren’t the only consequences of rising rates. Higher interest rates may also mean lower approval values on borrowers’ mortgage applications.
“If you’re a buyer, things are going to get more expensive, so you may be able to borrow less money,” said Tendayi Kapfidze, chief economist at LendingTree. “It’s less affordable to purchase a home or get a mortgage.”
But lower approval amounts may not be a bad thing. Buyers sometimes make purchase decisions based on the maximum amount for which they can qualify, rather than based on what makes sense for their budgets, which can lead to long-term financial strain.
“What a lot of people will do is start looking for homes without truly understanding their borrowing power, and then they try to stretch themselves to a point that might not be comfortable,” Gorman said. Instead, he recommended meeting with a loan officer and finding out your borrowing ability, then beginning the search from there.
Keep calm and carry on
It’s also important to keep perspective when you read that interest rates are increasing. Yes, they are higher than last year. But that doesn’t necessarily mean you won’t find an affordable property. Rates are still relatively low, as we noted before.
Stirling said that the lower rates are, the more compressed payments become. In other words, the increase in monthly payments may not be as substantial as borrowers fear. He offered the example of a traditional $300,000 mortgage in which payments on the principal and interest at 4% would be about $1,432. At 5%, he said, the payment would increase to about $1,610.
“The difference isn’t insubstantial but it’s not the end for many people,” Stirling noted. But with rates still closer to the zero end of the spectrum, even a modest increase “still allows [borrowers] to take advantage of the great opportunity of where rates sit today.”
Boomer said rising interest rates could encourage borrowers to look at products they might not otherwise have considered. Rather than choosing a 30-year fixed mortgage to lock in a low rate, they might explore hybrid adjustable-rate mortgages (also known as ARMs) or low down-payment options that have been introduced to the market in recent years.
Hybrid ARMs typically include low introductory rates before the variable rate period begins at three, five, seven or 10 years, depending on the loan structure, Stirling explained. “If the consumer has no intention of living in the property beyond this fixed period, an ARM can be a great option, as the payments on the home will be lower than that of a 30-year fixed rate,” he said.
Comparison shopping still key
Whatever type of mortgage you pursue, it’s worth meeting with several different lenders and comparing their products and rates. Even with interest rates increasing, you may be able to find a better-than-average offer, according to Kapfidze.
“Let’s say the average mortgage rate is 4.5%. That means people are getting rates ranging from 4% to 6%, so there’s a wide range of rates available in the marketplace,” Kapfidze said. “The more you shop around, the more likely you are to find a favorable rate.”
The key to making the right buying decision is education. Stirling recommended getting in touch with a loan officer early on to determine your options. Jorge Davila, a vice president in the direct lending department at Flagstar Bank, suggested that borrowers ask questions until they feel comfortable with their purchase decisions and fully understand how the rates they’re offered will impact their payments. “It’s all about understanding what you’re looking for as a buyer, what makes sense for you and your family price-wise,” he said.
You can compare loan offers online by using LendingTree’s marketplace.
How rising interest rates impact sellers
Homebuyers aren’t the only ones who may be calibrating their plans in light of rising interest rates. Sellers, too, will need to decide how they respond to this shift in the market. If buyers move quickly to purchase homes before interest rates rise further, sellers may find themselves able to move their property quickly.
But once they’ve sold their homes, they’ll need a place to move — and that means they may end up having to take out a loan at a higher interest rate than what they pay on their current properties. Kapfidze describes this as a lock-in effect. When rates rise, some owners opt to stay in their homes rather than risk paying more for a new house.
If you choose to stay in your home, you don’t necessarily need to maintain the status quo, though. Kapfidze said that instead of selling, some homeowners will apply for home equity loans or lines of credit and improve their existing houses. Knowing this, lenders may offer competitive terms on home equity products, so sellers should consider a variety of offers before deciding which to accept.
Buyer or seller, the consensus among these experts was to maintain perspective and focus less on short-term increases and more on the long-term implications of your buying and selling decisions.
“People are going to consistently be moving for jobs, for schools, for families growing, downsizing, so the housing market will always be one that is necessary and relatively strong,” Gorman said. “So we tend to tell clients, worry less about the rate environment and worry more about what’s best for you.”
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