By Dian Hymer
Recent increases in interest rates have had buyers scrambling. When interest rates rise, so do monthly mortgage payments, which makes buying a home more expensive. It's hard to think about paying more to buy a home when weeks earlier it would have cost a lot less. What can you do to ease the pain of higher rates?
One option is to scale back your price range. A less expensive house means a lower mortgage amount and lower monthly payment. But it also might mean a less desirable neighborhood.
This isn't too appealing especially if you're buying in a high-priced area like the North East or West Coast where it's not uncommon to pay $500,000 for a starter home. If you drop back to a lower price range, you may find that you can't find a home to buy in the area where you want to live.
A more palatable option for many buyers is to switch mortgage products. Let's say you qualified for a 30-year fixed rate mortgage when rates were in the mid-5 percent range. But, at close to 6.5 percent, you no longer qualify.
A popular alternative is an adjustable rate mortgage that's fixed for five years. During the first week of September, these mortgages were being offered in the mid-5 percent range.
Before signing up for a 5-year fixed-rate loan, make sure you understand how the loan works. After the first five years at a fixed interest rate, the loan converts to an ARM with an interest rate that fluctuates.
Interest rates could be significantly higher in five years than they are now. If so, refinancing into a lower-interest-rate fixed mortgage at that time may not be possible. You don't want to find yourself having to sell your home in what could be a down market. So, make sure you can afford to make higher mortgage payments if that's what you're stuck with at the end of five years.
House Hunting Tip: Some 5-year fixed-loan buyers are opting for the no-point option. This way, if the economy slows and interest rates drop again, they can refinance into a fully fixed-rate loan and pay points at that time to buy down the interest rate. This avoids paying points twice. Points is a term lenders use for the loan origination fee. One point is equal to 1 percent of the loan amount.
Mortgages that are fixed for seven or 10 years are also available. Although interest rates on these loans are better than they are on 30-year fixed loans, they're not as competitive as 5-year fixed ARM loans.
Interest-only mortgages are also gaining in popularity as buyers search for a way to keep their monthly payment down as rates rise. The entire monthly payment goes to interest so none of the principal (the amount borrowed) is paid back during the course of the loan.
These loans can be risky if the market softens, prices drop and you have to sell. Some interest-only loans convert to an amortizing loan after a number of years. Once this happens, you will start repaying the principal with each monthly payment.
Sellers who are looking for a way to enhance the salability of their home might offer to pay points to buy down the interest rate for the buyers. As far as the lender is concerned, either the buyer or seller can pay points. However, under normal market conditions, buyers usually pay points.
The Closing: If a seller agrees to pay points, the lender may call this a credit for buyer's closing costs. Lenders have limits of how much they will permit a seller to credit for closing costs.
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