Strategies Home Buyers Can Use to Beat Rising Interest Rates

Are you a would-be home buyer who is upset because you missed out on the extremely low interest rates that were available until recently when the Federal Reserve started raising rates to try to lower inflation? While the market is shifting, making more homes available at a lower price, rising interest rates are increasing monthly mortgage payments. Ask your Citywide loan officer if you should consider an Adjustable-Rate Mortgage (ARM) as a strategy to lower your monthly payments, at least for the initial period of your loan.

According to the Mortgage Bankers Association, ARM applications jumped by 30 percent over the previous year at the beginning of July 2022. The explanation is likely that more borrowers are trying to cut costs with an ARM’s initial lower rates.

An Adjustable-Rate Mortgage is a home loan with a variable interest rate. ARMs are also called variable-rate mortgages. With this type of loan, the initial interest rate is fixed for a specified period of time, usually at a lower rate than a fixed-rate mortgage. After the initial period—usually 3-10 years, the interest rate on the outstanding balance is periodically reset at yearly or monthly intervals, based on the state of the economy and the general cost of borrowing.

One thing that can make a difference is the ARM cap on your loan, or the limit on how much the interest rate and/or payments can rise per year or over the lifetime of the loan, after the initial loan period has passed. The cap can be influenced by your credit score and your lender.

  • A lower interest rate, especially the introductory or teaser rate, will save you money, especially when interest rates are high.
  • Your monthly payment will be lower initially than most traditional fixed-rate mortgages, and you may be able to put more money down toward your principal.
  • Using an ARM to finance a short-term purchase, such as a starter home, or a home that you intend to flip, allows you to pay lower monthly payments, especially if you sell before the initial loan/lower interest rate period ends.
  • You won’t have to make a trip to the bank or your lender to refinance when interest rates drop, because you’re probably already getting the best deal available.
  • You could refinance into a fixed-rate mortgage when interest rates drop if you meet your lender’s qualifications, and you feel more financially stable with that going forward.

Having too much mortgage debt in retirement may be risky, especially if you are living on a fixed income of Social Security and perhaps a pension. You might not have the wiggle room for a big increase in expenses.

  • Payments could go up. Once your loan enters the adjustable-rate period, your payments could rise or fall depending on the market. While lenders generally have rate caps in place, you might still find yourself making payments that are much higher compared to what you started with.
  • Negative amortization. Although interest rate caps can help keep your monthly payments more manageable, they can also lead to negative amortization. This occurs when  payments don’t fully cover the interest you owe, and the unpaid interest is added to your loan balance—meaning you could end up paying interest on your interest.
  • Harder to plan for the future. After the fixed-rate period of your loan, your payments could fluctuate frequently, which can make it hard to make other financial decisions. You face a greater risk if you’re already making the highest payments you can afford.
  • ARM mortgages can seem complicated to understand. There are features that t you should be aware of, such as caps, indexes, and margins, before you sign your mortgage contracts. Be sure to get advice about your options from an experienced loan officer.

In addition to an ARM loan, your loan officer might advise you to:

  1. Buy down your rate with points. We’ll write more about buydowns in our next article.
  2. Choose a shorter loan term. This also benefits those for whom an ARM is a good choice.
  3. Make a larger down payment. If you can come up with the money to do this, the overall interest you pay will be lower. See our related articles on down payments:
    1. How much should one save for a down payment?
    2. How to come up with a down payment for a home
    3. How to save for &/or acquire a 20% down payment
  4. Improve your credit rating: see our article Tips to boost your credit score.

Talk to a Citywide loan officer before you find the home of your dreams. He or she will help you to know what you can afford. Use an experienced real estate agent who works with Citywide to help you find a home that will meet your needs at a price that is right for your budget.

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