Today’s homebuyers are likely feeling the strain on their purchasing power as the affordability of homeownership shrinks.
Such anxiety is understandable given that mortgage rates have roughly doubled since the start of 2022. But if you’re waiting for mortgage rates to fall before jumping into the market, you may be waiting a while.
The 30-year fixed mortgage rate averaged around 3% at the start of 2022, and shot up to around 7% by the end of the year. In 2023, rates continue to fluctuate between 6.5% and 7%. While it’s impossible to know exactly where mortgage rates will go in the latter half of 2023, some experts predict moderation. For instance, Fannie Mae expects rates to sit near 6.8% in the third quarter of 2023, and drift down to 6.6% by the end of the year. That’s not a dramatic decline, but when it comes to mortgage rates, even a few tenths of a percentage point can add or subtract tens of thousands of dollars over the course of your loan.
“Mortgage rates are an important factor to consider when making a homebuying decision, but they shouldn’t be the sole basis for your decision,” said Jeffrey Taylor, founder and managing director at mortgage processor and risk compliance consulting firm, Digital Risk.
What mortgage rates will do in the future isn’t within your control. There are steps you can take, however, such as building your credit score and maximizing your down payment, that won’t only help you score a lower mortgage rate but will put you in an overall better position to purchase a house when you’re ready to do so.
5 things buyers can do to prepare for when mortgage rates fall
If your goal is to become a homeowner, here’s what to do instead of waiting for mortgage rates to drop.
1. Get your credit score in shape
Your credit score is a key factor in determining whether you qualify for a mortgage and at what interest rate. You may qualify for a lower interest rate if you have strong credit. If yours is on the low side, take steps to improve your credit before seeking preapproval for a mortgage.
When it comes to your credit history, lenders are primarily looking for your ability to make reliable payments. But they also want to see low credit utilization, a good mix of credit and not too many credit inquiries.
AnnualCreditReport.com allows you to monitor your credit on a weekly basis. You can pull your report for free up to once a week through 2023. Errors, such as incorrect account balances, and identity theft can bring down your score, so you should dispute such issues as soon as possible.
A strong credit score, around 750, can help you qualify for the most competitive interest rate. You can get a mortgage with a low score, less than 600, but it likely means you’ll end up with a higher mortgage rate.
2. Save for a larger down payment
With mortgage interest rates being what they are, and home prices yet to come down significantly, now might not be the right time for you to buy a house -- and that’s OK. A silver lining of this inflationary environment is that it’s a great time to save for a larger down payment.
The Federal Reserve’s rate hikes make things like credit card debt and home equity lines of credit, or HELOCs, more expensive. But on the flip side, higher interest rates mean you can get a better return with your savings account or certificate of deposit, or CD.
You can take advantage of compounding interest by saving for your future down payment and closing costs. Some of the best high-yield savings accounts offer interest rates massively higher than traditional savings accounts.
The higher your down payment, the lower your loan-to-value ratio, or LTV will be. “Any way to reduce your loan-to-value ratio could potentially result in a lower interest rate,” Taylor said. In addition, a 20% down payment will also help you avoid paying private mortgage mortgage insurance, or PMI.
Pro tip: It’s worth looking into whether you qualify for a program that offers down payment or closing cost assistance, which often comes in the form of a grant or affordable loan. These programs are run by lenders, federal and state housing agencies and local housing authorities. Each program has different requirements, so research what’s offered in your area and which lenders accept this type of financial assistance.
3. Improve your debt-to-income ratio
Your debt-to-income ratio, or DTI, is a crucial factor that lenders consider when assessing your eligibility for a mortgage and determining the loan amount you qualify for. Improving your DTI has multiple benefits. It will not only make you a more attractive borrower to lenders, it will also put you in a better financial position to take on a mortgage.
Expressed as a percentage, you can calculate your DTI, by dividing your total monthly debt payments by your pretax monthly income.
Mortgage lenders look more favorably upon borrowers who have a low DTI -- ideally 36% or less, said Taylor. “The more financially stable a borrower appears, the better chances for favorable interest rates,” he added.
4. Explore all of your options
If you’re not ready to jump into the housing market just yet, it’s worth doing some research to figure out what mortgage type and loan term best suits your needs.
While most homebuyers opt for a conventional loan, there are other options available to qualified buyers including government-insured loans, such as FHA, VA or USDA loans.
- FHA loan: This loan is offered by private financial institutions under regulation and insurance from the Federal Housing Administration. An FHA loan requires a minimum credit score of 500 if you put 10% down or 580 if you put the minimum 3.5% down. These loans are especially attractive to first-time homebuyers who may not have a deep credit history.
- VA loan: A VA loan is backed by the Department of Veterans’ Affairs, and is available to current service members, eligible veterans and certain surviving spouses. A VA loan offers little to no down payment options, no mortgage insurance payments and a streamlined refinancing process if you decide to do so later on.
- USDA loan: Borrowers with lower income in rural areas can take advantage of the rural development loan program, administered by the US Department of Agriculture. Such a loan offers a zero down payment option and has fewer fees than an FHA loan, but you’ll have to live in a qualified area to get approved.
You’ll also want to pay attention to both the type of interest rate and loan term.
- Rate-type: You can either choose a fixed-rate mortgage or an adjustable-rate mortgage, or ARM. With a fixed-rate mortgage, there are no surprises: Your interest rate will remain the same for the entirety of your loan. An ARM, however, works a bit differently: You’ll have a set period, say five years, with a fixed interest rate -- which is usually lower than the going 30-year fixed rate. After that, the interest rate will adjust with the market each year. That means your monthly payment could get more expensive -- or could get cheaper -- depending on the market.
- Loan term: The length of your home loan also plays an important role in determining your interest rate and monthly mortgage payment. Shorter-term loans typically have lower interest rates but higher monthly payments because you’re paying it off in a shorter amount of time. With a shorter-term loan, you’ll save money in interest, but you’ll need to ensure you’re comfortable with a higher monthly mortgage payment. On the flip side, longer-term loans usually carry higher interest rates, but come with the benefit of lower monthly payments.
5. Compare offers from multiple lenders
Taking the time to shop around and compare offers from multiple lenders is always a good idea, but particularly in an elevated rate environment. Mortgage interest rates vary with each lender, so consider getting loan estimates from at least three financial institutions.
Pro tip: You can limit your exposure to rising interest rates by locking in a rate while you’re shopping. Rate locks can last anywhere from 30 to 90 days depending on the lender, and some lenders even allow you to extend the lock period or adjust the rate down if market rates fall during the lock period -- though typically for a fee.
How to approach today’s housing market
Patience is key when it comes to the housing market.
Experts recommend against banking on home prices or mortgage rates making any sudden or sustainable downturns. Instead, focus on making well-informed decisions that will benefit your financial outlook.
“The decision to wait it out or take the plunge in the current interest rate market should be based on a careful assessment of your financial readiness, long-term plans, personal circumstances and what you qualify for,” Taylor said.
Set realistic expectations
The housing market is still reeling from a tumultuous few years and it’s unlikely that mortgage rates will drop dramatically any time soon. You may need to put your homebuying plans on hold for a few months, but your best recourse may be to adjust your expectations.
While rates are expected to moderate in the coming months, it’s unlikely we’ll see a return to rates in the 3% range any time soon, if ever. In fact, those record low mortgage rates were part of what led to the high inflation of the past year. For the time being, a mortgage rate in the 6% range is the new normal. When the impact of the Fed’s rate hikes is palpable, and inflation cools off, mortgage rates will likely follow -- albeit at a slower and nonlinear pace.
Monitor trends in your market
Because every real estate market is different, it’s worth talking with a real estate agent when shopping for a home. They can provide you with details on what’s common in your local market. Ask them about:
- Inventory: If there are more homes for sale in your area, it might be easier to find a property in your budget. Nationwide, though, housing availability remains tight compared to pre-pandemic levels as fewer owners are willing to sell their homes and give up their existing low mortgage rate in exchange for today’s higher market rates.
- Bargaining power: While we’re not in a buyer’s market yet, potential homebuyers have more bargaining power now than during the pandemic homebuying boom. Thanks to a less competitive market, you likely won’t have to waive contingencies, like inspections or appraisals. You may also be able to ask for the seller to buy down your mortgage rate using points.
- Home prices: As mortgage rates tick up, buyers’ borrowing power drops, and sellers have to deal with lower demand. As a result, sellers in some areas are lowering their listing prices -- but not everywhere. In many regions, low inventory continues to prop up prices.
Make the right homebuying decision for you
No matter what’s happening in the market, people will always need to buy homes, and you might be one of them. While a mortgage rate above 6% is not the most enticing, remember that it doesn’t have to be forever. If you lock in a mortgage, you can still refinance when rates do eventually inch lower.
Rather than hyperfixating on mortgage rates, experts recommend homebuyers focus on their own finances and determine the extent of what they can afford for a monthly payment.
The consensus? Keep a finger on the pulse, but control what you can control.
The bottom line
The current housing market is tough, with elevated mortgage rates and stubbornly high home prices, but it still may make sense to buy, if that’s what’s right for your personal and financial situation. Rather than waiting for mortgage rates to drop, you can take steps by doing things like improving your credit score and saving for a larger down payment to put yourself in a better position to purchase a house.
Article from CNET.com
