There Are Still Good Mortgage Deals—Even When Interest Rates Inch Up
When mortgage interest rates are low, homes are more affordable. That’s a givenn. You can get more home for less money, and you have a lot of home buying and mortgage options. When the rates go up your options change, especially when you look at the math behind what you might call the " one-will-cost-you-11" formula. You still have options, however, and quite affordable ones. They are just different. In other words, there’s no need to panic when the rates inch up. Look at all of your options, instead.
" Whenever mortgage rates increase by 1 percent, a family`s gross income must increase by 11 percent in order to purchase the same house they could have purchased before the rates went up," explains Gary Crabtree of Affiliated Appraisers of Bakersfield, California. Simply put, you have to make 11 percent more money in order to match the additional cost of a 1 percent increase in the mortgage rate. Let’s say you make $50,000 a year and you just meet the income-qualification requirements for a loan at 5.5 percent. If everything else stays the same—the size of the loan, down payment, credit history, debt-to-income ratio, and so on—you would have to make $55,500 to qualify for the same loan at 6.5 percent. This is not a secret. " It’s just one of those numbers that people in the industry have learned to use," Crabtree explains. " It’s a simple math calculation." Countrywide Mortgage’s Doug Perry agrees. " Roughly speaking, that is essentially a true statement when you are talking about a conventional, 30-year, fixed-rate mortgage." The senior vice president of the consumer markets division in Calabasas, California, points out that the rules change when you look at different types of loans. Wells Fargo Mortgage’s Jim Stavenger, also agrees. The vice president and Midwest regional sales manager in Sioux Falls, South Dakota, adds, " I think that even with the slight up-tick in rates that we’ve seen in the last 30 days or so, consumer buying power is still there. It is still a great time for first-time homeowners to purchase, or for people to move up into a larger home." What they need to do is buy that home with a different type of loan. When interest rates go up, house shoppers start to feel a lot of pressure, Perry adds. " Most companies don’t give 11 percent raises, so people have to look at all their options." Perry and Stavenger agree the option that more and more homebuyers are considering is an adjustable-rate mortgage (ARM), but there are others. Perry and Stavenger add that depending upon your income and credit history, some lenders allow a higher income-to-debt ratio. Others allow you to take out both a first and a second mortgage. But the focus is on ARMs, which start off at an interest rate lower than that of a conventional 30-year loan. The rate can and normally does change, however—often upwards. How soon it will change and how high it can go are all factors that have to be considered. " There are one-year, three-year, five-, seven- and 10-year ARMs," Perry says. The initial rate of an ARM depends upon the length of time that loan will last until the rates change. For example if the 30-year rate is 6.125 percent, the rate for a 15-year conventional mortgage will be about 5.5 percent. You can likely get a one-year ARM for 3.625 percent, a three-year for 4.375, and a five-year for 5 percent. Why? One of the basic truths of lending is that the longer the life of a loan, the higher the interest rate. No one really knows what either the economy or the interest rate will be in 30 years--or in 20, 10, five, or even in one year. For that matter, no one really knows what it will be next week, let alone next month. So lenders want as much return on their investment (interest) as possible. The longer their money will be tied up, the more interest they will want. Even though an ARM is a 30-year loan, the interest rate will adjust after the initial period. For a one-year ARM it will happen at the end of one year, for a three-year after three years, and so on. After the introductory period your rates could adjust every year, depending on economic factors. If you are shopping for an ARM make sure you get one with a ceiling and a cap. These will limit the amount the rate can adjust in any one year, and will also limit the total amount the interest rate can climb. Back in our parents’ day, and especially in our grandparents’ day, people tended to buy one house and stay there. Today we are a more mobile society. Do you really think you will be in the house you are in today, or the one for which you are currently shopping, for the full 30 years that a conventional mortgage lasts? How about 15 years? Ten? Five? Stavenger says, " The average life of a mortgage loan today is somewhere between five and eight years." After that the owner either refinances or sells. If you know, or even suspect, that you will be moving in five years, why take a 30-year loan? Using the figures given earlier, the mortgage rate difference between a five-year ARM and a 30-year conventional loan is 1.125 percent. The difference between a 30-year and a three-year loan is 1.75 percent. Since ARM interest rates are lower, the payments will be smaller. So will the amount of income you need to qualify for these types of loans. " An ARM still allows the same buying power that consumers had when rates were lower." Since no one knows exactly where interest rates will be tomorrow, the best any of us can do is find the best deal we can get when we buy a house. In today’s market, that deal is likely to be an ARM, and you probably won’t need an 11 percent raise to qualify for it.
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