Hedging against higher rates when buying a house
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By Scott Sheldon  July 4, 2013 09:51 am

Anyone buying a home is all too familiar with the fact interest rates have risen sharply and dramatically in the last several weeks. 

Buyers and homeowners alike, should expect rates to be at these levels as long as positive economic data continues to surface in the financial markets. Unfortunately for many, because of current lending standards, higher rates reduce borrowing ability – and in some cases purchase price – risking the ability to perform on a real estate purchase contract.

Home buyers who were qualified just months ago, in the mid 3s are now upwards of more than 4 percent for the same type of financing, e.g.  a 30-year fixed rate mortgage.

 

Tips to combat higher interest rates

The last thing any responsible home buyer wants, is to get the fantastic news of getting into a contract only to realize their potential mortgage payment has now etched up more than $100 per month or thereabouts.

 

What to do

• Budget for a higher payment now: Give yourself a $200 per month margin of error. Doing so will allow you to absorb news of higher rates as your target mortgage payment can be adjusted. For example, let’s say you’re buying a home for $325,000  and your target mortgage payment is $1,800 per month. Give yourself a window of $2,000 per month. In fact, if you can’t give yourself a margin of error (things sometimes change in a mortgage/real estate transaction), you shouldn’t be buying the house as your stretching your comfort zone. On the other hand, a higher mortgage payment means a higher interest rate, which also means larger tax benefits. (Speak with a qualified tax professional.)

• Increase down payment: If possible,  increase the down payment amount. Lowering the loan amount reduces the principal and interest payment and the subsequent interest paid over the life of the loan. This action also reduces any applicable mortgage insurance percentages.

• Raise deductible on fire insurance: If you’re setting up an escrow account with your mortgage lender for your mortgage payment to include taxes, insurance and principal and interest, your mortgage payment will be higher. But you won’t have to worry about paying taxes and insurance separately as these figures  are built into your total payment. Raising the deductible on fire insurance reduces the annual premium due and the subsequent monthly mortgage insurance payment, thus reducing your total mortgage payment.

• Qualify at a higher rate: Have your mortgage company qualify you at a higher interest rate. Here’s an example: let’s say you qualify for a 30-year fixed rate mortgage at 4.875 percent, and you base your payments assumptions on a higher interest rate. Market rate is at 4.375 percent, so if you qualify at 4.875percent by definition, you will also qualify at 4.375 percent. 

Because the lender is intentionally qualifying you with a higher interest rate, if rates continue to rise, you’re in the clear because you’re taking the ultraconservative approach in your decision making. The lesson is get current rates when speaking with your lender and also have them run scenarios .5 percent higher in rate. This way you can hope for the best, plan for the worst and come out successful somewhere in between.

As inventory supply is low and the seller’s market remains, reducing purchase price to combat a higher interest rate is a risky proposition. The market competitiveness supports the seller’s likely choice to simply move to a different buyer who is otherwise stronger on paper.

What to remember

Interest rates do move every day – lately multiple times per day every day. If you’re in the process of finding a home to purchase, don’t let the prospectus of higher mortgage rates deter you from the bigger picture. It very well may take multiple purchase offers spread out over a period of months in order to get into contract anyway. Pulling the plug too early over interest rate concern could be premature, as rates will continue to move during all of that time purchase offers were made, of course possibility of improving.

Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.

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