If you’re thinking about buying a home, or refinancing your current residence, the news that the Federal Reserve approved raising its benchmark interest rate from 0.5 percent to 0.75 percent last December 14 might have just been a blip on your radar.
But what should have caught your attention wasn’t just that the rate inched up. Actually, something much more dramatic happened that day: Fed officials said they expected three more rate hikes this year, two or three in 2018, and three in 2019.
To get an idea of how the Fed’s actions might affect your homebuying decision, we talked to Danny Valentini, Regional Mortgage Manager, HomeServices Lending. Of course, working with a knowledgeable real estate agent is always a wise idea, because it’s part of an agent’s job to keep up to date on lending practices.
Why did the rate go up?
The Fed has been supporting a policy of low interest rates since the Great Recession of 2008 in order to stimulate economic activity. Today’s metrics show that the U.S. economy is close to full employment and is continuing to report a strong job-growth rate. With the vigilant eye against any signs of inflation, the Fed finally has an opportunity to bring rates to a more historically realistic level.
How will the rate hike affect buyers, including first-timers and upward movers?
The median home price in Southern California (San Diego, Orange, Los Angeles counties) is between $560,000 and $600,000, but the region also has one of the lowest affordability indexes in the country. In San Diego County, for example, the affordability index is close to 24 percent, which means only 24 percent of median-income households can afford a median-average home.
If you assume a borrower in Southern California has already maximized their household monthly qualifying payment, a rate increase of one-quarter of 1 percent can reduce the affordable sales price by 3 percent–that’s a big difference. Let’s take a $600,000 home purchase as an example. In order to have the same mortgage payment with a quarter-percent higher interest rate on a 30-year mortgage, the borrower would have to either find a house that’s $18,000 less expensive, or put an additional $18,000 down.
Why are more rate increases predicted?
Besides hints expressed by the Fed, the biggest factor that may push rates higher could be the Trump administration’s fiscal (taxation) policy alongside other stimulus strategies that will spur economic activity. If the economy heats up, you may see further pressure on interest rates rising, but we could also see a more favorable affordability index due to more jobs and higher wages. We just don’t know yet.
How will the increases affect home equity loans, lines of credit, and adjustable-rate mortgages (ARMs)?
Higher interest rates will affect all kinds of lending instruments. Credit cards, lines of credit and 30-year mortgages use different calculations and parameters to qualify a borrower, but in general, higher rates will make affordability a little more challenging. The higher the interest rate, the more difficult it is to qualify.
Why are ARMs making a comeback? Are they as risky now as in previous years?
ARMs fix rates for a five-, seven-, or 10-year period, usually at significantly lower rates than the traditional 30-year fixed mortgage. The seven- and 10-year ARMs can definitely help borrowers qualify for more house, while keeping their monthly payments significantly lower than a traditional 30-year fixed mortgage would have. So, I think you’ll see more borrowers taking these types of loans if interest rates continue to rise. They will be an important part of the overall home-financing market.
Will the FHA’s recent lowering of the MIP (mortgage insurance premium) by a quarter-point help buyers?
Absolutely! The lower monthly premium will help more prospective homeowners afford more mortgages.
What is the best advice now for prospective homebuyers?
The first thing they should do is get “pre-qualified” with a reputable lender. They can ask their real estate agent for a few names, since they work with lenders every day.
“Pre-qual,” “pre-approval,” “credit approval,” and “loan commitment“ are all interchangeable terms that are used, and they can confuse borrowers and real estate agents. The mortgage industry has not standardized definitions of what these terms mean.
My best advice, regardless of what term is being used, is it important that a “pre-qualification” is not limited to a phone conversation with a lender. A minimum requirement of a true and viable “pre-qualification” should include a loan officer taking a loan application, plus analyzing income, credit, and asset documentation. The strongest “pre-qualification” letter is one that is issued by the lender’s underwriting team, also sometimes known as a “commitment letter.”
In general, the more the loan officer asks up front, the better the “pre-qualification” may be. Be patient and understanding.
How else can a home purchase become a reality?
Other things a borrower should consider are utilizing the benefit of the 7-year and 10-year ARMs, adding a co-borrower to help qualify, or obtaining gift money to help with a larger down payment in order to lower the loan amount. Finally, ask your agent for a reputable mortgage loan officer, but also do some homework yourself.