I hate to break it to you, but barring another global disaster or pandemic, we are unlikely to see mortgage rates drop to the 3% playing field again in our lifetime. The COVID-19 pandemic shutdowns seemed to last an eternity, so mentally and emotionally what happened during those times seems like the way things have always been. The past three years have felt like a decade, am I right? We are all exhausted.
The best advice one can offer for any decision-making process is to focus on what we have in front of us today. The past is gone, and the future is never certain. That being said, my team is constantly asking for feedback from our market partners and working to come up with programs to alleviate pain points. The pain points in most people’s minds right now are high interest rates combined with high home prices.
Let’s start with some perspective.
Rates are currently below historic average by more than a full percentage point! The important thing to remember is that interest rates are temporary. When they drop, you can refinance, if that is what makes the most sense for how long you plan to keep the property.
Home prices… well, those are historically high, there is no argument there. Like they’ve been saying, “The best time to buy a house is five years ago.” And I like to say, “The second-best time to buy a house is today!”, because the trending forecast is for continued growth year over year. The good news is that several sources (1,2) are reporting that sellers are settling for an average 4-5% asking-price reduction. But before you start asking for a price reduction, let’s look at the numbers. Maybe there is a more advantageous way to proceed.
Permanent Interest Rate Buydown
Commonly known as “paying points”, this is a strategy where upon you pay additional fees in exchange for a lower interest rate for the term of your loan. In lieu of a price reduction, you could make an offer at full sales price, but with a seller concession that would cover an interest rate buydown! Typically, this is a win-win situation because the cost to buydown the rate may be less than the price reduction they were considering.
One quick side note on this, as it’s a pet peeve of mine: While you do, in fact, “pay points” to the lender at closing, this is not profit for your lender. This is a fee your lender in turn pay to secure your lower interest rate. I’ll be posting a longer explanation on this soon and will come back here to link to it. Watch for a post on Loan Level Pricing Adjustments, which loan officers rarely educate their borrowers on.
Know that with this feature you are paying to buy the rate down for the entire term of your loan – typically 30 years. There is a “break even” point before which refinancing will mean throwing money into the fire. If rates drop to a point where refinancing is going to save you a significant amount of money each month, it may be worth that loss, but let’s look at some other options.
Temporary 2/1 Interest Rate Buydown
A 2/1 buydown is like the permanent interest rate buydown outlined above, except that the rate is only being bought down for the first two years.
Example: If you currently qualify for 6.125% interest rate and employ a 2/1 buydown scenario, your interest rate would be 4.125% for the first year, 5.125% for the second year, and from the third year onward you’d be at that qualifying rate of 6.125%. This is a smart move if you’re onboard with most experts who are forecasting a significant interest rate drop in the next couple of years. For my clients, I run the numbers to pinpoint when the most financially advantageous time to refinance is based on the existing mortgage note rate, current interest rates on the refinance, and how long they plan to retain ownership of the home. There are many important factors to consider before running out and refinancing to get “a better rate”. In some cases, refinancing is NOT the best decision.
The funds required for the 2/1 buydown are collected at closing by your title company and held in your escrow account, to be applied to your mortgage payment each month. This buydown can be funded by the buyer, the seller, or split between them however they like. If you’re in a situation where a lender or realtor credit is available, that can be applied toward this as well!
Another fantastic thing about this special loan feature of is that if you refinance early, you will be refunded any of the unused funds! You quite literally cannot lose with this option. That is NOT the case with the permanent buydown.
It is important to know that you’ll have to qualify for the mortgage at the highest rate (6.125% in this example). You’d also want to make sure you’re comfortable with that higher interest rate payment should market predictions be wrong or you cannot afford to refinance at the right time. Refinancing comes with a cost, so you should be factoring that expense into your decision and saving for it accordingly.
Temporary 3/2/1 interest rate buydown
This loan feature is the same as the temporary 2/1 buydown explained above but adds an additional year. So, in the 6.125% example, your first-year interest rate would be 3.125%, so on and so forth, until year four when you’d revert to 6.125%.
This is an option you would choose if you had a high amount of seller credit at your disposal or want an additional year before considering a refinance. This might be the best option to consider if you’re purchasing with a very small down payment and want to time your refinance for when your home value has increased enough to remove the requirement for mortgage insurance, thus saving you even more on your monthly debt!
Adjustable-Rate Mortgages
Commonly referred to as ARMs, adjustable-rate mortgages are typically priced better than standard conventional mortgage pricing. ARMs became more popular this past year for obvious reasons – rates are higher now and expected to drop in the future. As such, those using ARMs are gambling on never having to pay those top end mortgage rates. This may be a good option for those in a solid financial situation, who are highly attentive to market conditions, but there are inherent dangers with this loan product.
In a recent survey conducted by US News (3) 43% of respondents indicated they regretted choosing an ARM, with the top reason being that their interest rate adjusted to a higher rate than they had expected.
I would only explore ARM options for borrowers who have a strong enough financial portfolio to bail themselves out should the worst happen. Putting first time buyers with limited resources or financial experience into an ARM is a huge disservice, at best. This is a product that requires you to remain vigilant to market conditions — as we’ve seen recently, the market can make radical, unexpected changes overnight. If you aren’t paying attention, you could find yourself in a very high interest rate product that you can no longer afford. Many foreclosures are tied to ARM products.
Final word
As you can see there are a multitude of factors to take into consideration when making your decision. It’s important to have a mortgage loan officer who takes their fiduciary duty to their clients seriously and will take the time to explore and fully explain the pros and cons of each option, regardless of complexity or commission impacts. (Hint: That’s me)
Happy house hunting and remember to call the Mortgage Dogs for your pre-approval BEFORE you start shopping!
