As interest rates rise, some homebuyers are debating whether to buy now or wait for rates to come down. Others are racing to buy before rates climb further.
Interest rates on fixed-rate mortgages have increased over 1.5 percentage point in the past few months. As rates go up, so does the cost of a house. Buyers who don't have the ability to pay more have several options. They can scale down and buy a less expensive house. They can switch from fixed-rate to adjustable-rate financing, which makes qualifying easier. Or they can drop out of the house hunt and wait for housing to become more affordable again.
Buying a less-expensive house makes sense as long as you buy a house that will suit your needs for four to five years. Moving is costly. It wouldn't make sense to buy a house that you'll outgrow in a year or two.
However, if you buy into a booming market where home prices are rising rapidly, buying a short-term house can be an excellent investment. In this case, postponing a purchase could cost you more than it would to buy now and move again in several years.
Even buyers who can afford fixed-rate loans are switching to adjustable-rate mortgages (ARMs) to save money. ARMs are still available with start rates in the 5-6 percent range. Buyers who are having difficulty qualifying at higher interest rates should shop around for an ARM program that qualifies borrowers based on the starting interest rate. If the initial ARM rate is a discounted rate, lenders often require that you qualify at 2 percent above the start rate (that is, at 7 percent rather than 5 percent).
When considering an ARM, always look at the worst-case scenario. How long will the initial interest rate be in effect and what will it be after the first adjustment? How high can the interest rate go if interest rates continue to climb? How long will it take for the ARM rate to reach the maximum allowed?
FIRST-TIME TIP: Buyers who intend to move again within five years will probably save money by taking an ARM because of the current cost of fixed-rate financing. But make sure you won't be charged for early prepayment if you do plan to move again soon.
Buyers who can't live with the uncertainty of mortgage payments that fluctuate should consider one of the hybrid loan products. These loans have interest rates fixed for 3, 5 , 7 or 10 years. At the end of this time, the loan either converts to an ARM, or to another fixed rate, or must be paid off in full.
The initial fixed rate on these loans is lower than the rate on a fixed-rate loan that's due in 30 years. Another option for buyers who are nervous about the interest rate fluctuations is to select an ARM with a relatively stable index.
THE CLOSING: It's risky to wait for housing to become more affordable again before you buy. Although no one knows for sure which way rates will go in the future, there's speculation that interest rate increases lie ahead.
Dian Hymer's column is syndicated through Inman News Features. Send questions and comments care of Inman News Features, 5335 College Avenue, No. 25, Oakland, Calif., 94618.