As of April of this year, 30 year fixed mortgages are averaging 4.5%, up from 4% at the beginning of the year. Predictions are that we will end 2018 around 5%. And while we all miss the 3.5 to 3.875% we enjoyed in most of 2015 and 2016, we are still in a low interest rate environment.
So, will home prices come down? The cyclical nature of real estate or some other event may create some relief in Bay Area home prices in some unknown number of years. While higher interest rates may contribute to a slowing of home value appreciation, remember that the massive housing price declines in 2008 were not due to higher interest rates, but risky lending practices and the selling of even riskier investments packaged from those mortgages. The good news is that today’s mortgage practices are vastly different from those times. Nationwide licensing of loan officers and new consumer friendly Loan Estimates and Closing Disclosures providing more timely and more transparent information to home borrowers have replaced the “anything goes” nature of the business in the early 2000’s.
Why is the Fed raising rates? Contrary to what is advertised, the Federal Reserve does not directly control mortgage rate sheets. When “the Fed raises rates”, they are increasing the Federal Funds rate, which directly impacts the Prime rate. The change is seen in rates charged on Equity Lines of Credit and some credit cards. Mortgage interest rates are determined by the bond market and do not automatically increase each time the Fed takes action. The Federal Reserve has raised the Fed Funds rate 6 times since 2015, each time by 0.25%. The Fed Reserve uses the Fed Funds rate as part of their monetary policy to support the US Economy. As their data shows the economy improving, they have begun “normalizing” their policies by moving the Fed Funds Rate toward 2% from the 0%, which was in place to assist economic recovery.
Mortgage interest rates are subject to the emotion of the market and typically increase as investors move from the safety of bonds to the growth opportunity of the stock market. Rates sheets are updated daily and sometimes intraday during volatile markets.
Impact to affordability. So, enough with the economy lessons! What do higher interest rates mean to me as a home buyer?
Higher interest rates translate to higher payments. If you are borrowing $500,000 to purchase a home, your payment is roughly $150 more per month at 4.5% than it was at 4%. With a mortgage of $700,000, the monthly increase is closer to $200. How can you keep payments affordable?
– Should you pay points? Most loans provide the consumer the option of “buying down the rate”. In exchange for a one time up front cost, the interest rate is lower for the life of the loan. Typically, 1 “point” or 1% of the loan amount paid up front as part of closing costs, buys the interest rate down by 0.25%. As an example, on a $500,000 mortgage, an additional $5000 paid at closing reduces the monthly payment by $75. The up front cost is recouped in about 5 ½ years. For borrowers who have funds available, want to keep monthly expenses down, and expect to be in their home longer than the 5 ½ years, this strategy may makes sense.
– Should I consider an Adjustable Rate Mortgage? Fannie and Freddie have not yet been willing to bring back well priced adjustable rate mortgages, so home buyers using conforming loans will continue to see basic 30 year fixed mortgages being offered to them. Jumbo loans (over the national conforming loan limit of $453,100 or our high cost county limit of $679,650), offer lower interest rates for shorter fixed rate periods. These loans are paid off in the standard 30 years, however the interest rate is only fixed for 5, 7 or 10 years. After the fixed rate period, the interest can adjust each year based on a predefined index and margin and within a set of interest rate caps. Borrowers should take the time to fully understand the benefits and risks associated with these types of mortgages and should never assume that they can refinance at a later date.
As always, home buyers should carefully consider their options and work with an experienced, professional realtor and loan officer to make their home buying dreams come true.
If you would like a free consultation to evaluate your current options, please contact me at 925-394-7753 or firstname.lastname@example.org