Earlier predictions were that home prices would fall due to rising interest rates. Simply put, that hasn’t happened. While higher rates have slowed appreciation and added a few extra days on the market, home prices are actually climbing at about 4% this year, which is right in line with inflation. That main reason for this is simple supply and demand economics. Most of the country is sitting at historically low levels of inventory.
Sellers have been able to hold fairly strong this year even in the face of continued high interest rates and recession fears. The biggest contributing factor here has been the lack of inventory. People still have to buy due to job and lifestyle reasons such as growing families. With many people holding onto their homes because they have secured historically low interest rates, the buyers out there are having to compete in a market of deplenished inventory.
Additionally, with new home permits down 21% year over year, and new home starts off by 28%, I think it’s accurate to say that activity in the new construction sector has slowed. Builders continue to be hit by high financing rates as well as high material prices. Builders are also shying away from larger projects with bigger upfront costs and longer sales times of 3-5 years. We’re seeing more small builds of 20-50 homes.
Don’t try to time the market.
Just because mortgage rates are on the rise doesn’t mean you can’t buy a home this year. The keys will be knowing your budget, maintaining perspective, and having a plan.
Instead of trying to time your home purchase to a specific interest rate, focus on the non-financial reasons that make it the right time to buy. These can be life events such as marriage, having children or moving closer to aging parents to help with their care. Then work out the financial side of the equation.
As with any home-buying decision, the better prepared you are the more likely you’ll achieve your goal. These tips will help you handle rising rates — whether it means going ahead with a home purchase or taking a step back and regrouping.
Between 2021 and 2022, mortgage rates have more than doubled, from less than 3 percent to more than 7 percent.
The math on a 30-year, fixed-rate loan for a $600,000 house with a 10 percent down payment tells the tale: At a 4 percent interest rate, the monthly payment would be $2,500. At 7 percent, the payment is $1,100 higher, at $3,600.
“Every buyer needs to do a gut check” on how much house they can afford now. This is the time to be honest with yourself and to properly set expectations. Sometimes it’s important to realize that you’re not going to get everything you want in a home, and in fact it can be more advantageous to “Get into the game than to keep waiting.”
So, let’s get into some of the questions you may be asking yourself. Here’s what you need to know about refinancing later, tapping stocks or retirement accounts and how much house you can (really) afford to buy right now.
Do higher interest rates make it harder to qualify for a home loan?
In short, yes. Because higher interest rates mean your monthly mortgage payment will also be higher, the income required to qualify for a home loan goes up, too. When rates were 2.9 percent, for example, the average borrower needed an income of $133,450 to buy a $750,000 home with a 20 percent down payment. At a rate of 6.9 percent, that same loan would require an income of $195,700; the monthly payment would increase from $3,114 to $4,567.
Is it true that my housing payment should max out at 28 to 30 percent of my pretax income?
Financial experts frequently recommend keeping your housing payment within this range. But this is only a generalization. Depending on your personal circumstances, you may need to budget much less of your monthly income for housing to keep your finances under control. For instance, “you may have your kids in private school or have higher transportation costs,” says Isabel Barrow, director of financial planning for Edelman Financial Engines in Alexandria, Va. Barrow recommends breaking down your monthly expenses to truly determine how much you’ll need to stretch to afford the mortgage and whether you can cut down on discretionary spending.
At the end of the day, though, you’ll have to be honest with yourself: “If you now need $50,000 more in income to qualify for the house you thought you wanted, it may be that you need to find a less expensive house, wait for prices to come down, save more for a down payment or wait for a raise,” Barrow says.
How can I get a lower interest rate?
If you have extra cash, you can ask your lender to show you the difference in your monthly payment if you make a bigger down payment or pay extra to “buy down” the mortgage rate. Typically, “buying down” the rate involves paying a percentage of the mortgage balance (called a point) at closing to lower the mortgage rate for the life of the loan. One point is equal to 1 percent of the loan amount. The amount the rate will be lowered depends on the lender’s offer. Some lenders also offer to lower the rate for the first year or two for a smaller fee.
Before going this route, though, it’s important to consider how long you’ll stay in the house, which helps you determine the break-even point when you’ll recoup [the extra cash you’ll have to spend] with the savings on your monthly payment.
It may not be worth it if you’re in the house for just a few years.
Adjustable-rate mortgages (ARMs) also tend to become a popular option when rates rise, because they offer a lower initial interest rate, but they carry significant risk. For example, your initial rate on a 7/1 ARM could be 5 percent for the first seven years, then adjust upward annually. ARMs typically have caps on how much rates can increase each year and over the life of the loan; those limits are often 2 percent annually and a maximum of 5 percent. So, this loan could go as high as 10 percent. A homeowner who isn’t prepared for the adjustment might not be able to keep up with their payments and could lose their home. Many financial experts, caution against ARMs unless you are absolutely certain you’ll sell the property before the rate resets.
What are the penalties if I use money from my retirement account to buy a house?
It might be tempting to see the cash sitting in your 401(k) and decide to take an early withdrawal or borrow against it for your down payment. But this should be a last resort, says Momodou Bojang, a financial adviser and the CEO of Axiom Value in Rockville, Md.: “It’s best not to take money out of your retirement at all. You can borrow to buy a house, but you can’t borrow to fund your retirement.”
Plus, there are serious tax penalties to consider depending on whether you borrow from your 401(k) or take a withdrawal that you don’t intend to repay. “If you withdraw the money from your 401(k) rather than take a loan, you’ll pay a 10 percent penalty and income taxes on it at your regular income tax rate,” Barrow says. “This is a lose-lose situation, because if you’re borrowing because your home is hard to afford, you’re also going to have to work harder to save more to rebuild your retirement savings.”
Barrow says taking out a loan against your 401(k) is marginally better, because there’s no immediate penalty or tax consequences, but you’ll lose the long-term benefit of letting that money earn value while sitting untouched. In addition, if you don’t repay the loan quickly enough, or you lose or leave your job before it’s paid in full, you’ll be required to pay taxes and a penalty on the remaining loan balance.
The IRS has different rules for retirement funds held in an IRA account. “If you have an IRA, you can’t borrow from it, but you can take a withdrawal,” Bojang says. “You’ll pay a penalty and income taxes unless you’re older than 59½. First-time buyers get an exemption from the penalty.”
Should I cash in stocks to afford a house?
If you have non-retirement investment accounts, financial experts say tapping those to increase your down payment is preferable to eating into your retirement. But there are tax implications to selling stocks. “If you’ve owned the stocks for a long time and have a capital gain, you’ll pay a capital-gains tax” on the profit you’ve made on those stocks since first buying them, Bojang says. But he adds that the capital-gains tax will still probably be lower than the income tax you would pay on a withdrawal from a retirement account.
Still, no one is advising that you drain your savings and investments to get into a house. Indeed, once you become a homeowner, having cash on hand will be more important than ever. “You may need more cash reserves for an emergency when you own a house, because big expenses can crop up unexpectedly,” Barrow says. “We recommend keeping six months to two years of living expenses accessible.”
Can I refinance later when interest rates come down?
While inflation is cooling, interest rates remain high, which puts a damper on Americans' plans to buy a home or refinance their existing mortgages. The natural question many homeowners are asking themselves in this economic climate: Should I buy a home now at high rates and refinance later, or should I wait for rates to fall?
Robert Johnson, a professor at Heider College of Business at Creighton University, points out that purchase price and mortgage rate are the two primary financial factors potential homebuyers consider when buying a home, but there's a critical distinction between the two.
"What many fail to understand is that only one—mortgage rate—can be renegotiated," says Johnson. "Once a home is purchased, you can't renegotiate the purchase price. What this means, in my opinion, is that if you find a home you believe is priced attractively, I would be more apt to pull the trigger than if mortgage rates are attractive and home prices seem high. In financial terms, you have the optionality for the remainder of your mortgage to renegotiate terms. You don't have that option with a purchase price."
As the saying goes, "Marry the home, but date the rate."
Additionally, you may experience other unique benefits if you buy a home in the current climate. "Buyers who are in the market while interest rates are high may have certain advantages that they otherwise wouldn't, such as less competition and more negotiating power," states Afifa Saburi, senior researcher at Veterans United Home Loans. "While they still have the option to refinance, potentially more than once throughout their 15- or 30-year mortgage term, they also have the opportunity to build equity and wealth."
Regarding whether to buy now and refinance later or adopt a wait-and-see approach to , economist Peter C. Earle from the American Institute for Economic Research says it's hard to predict. "Typically, the rule of thumb is that one wouldn't finance unless the new mortgage rate to lock in is at least 0.75% to 1% lower than the established rate," says Earle.
The bottom line
No matter when you buy a home, the decision should be based on sound financials, namely, whether you can afford the payments and how long you plan on staying in the home long-term.
Refinancing also comes with upfront costs. Generally, you’ll have to come up with 1 to 1.5 percent of the new loan amount in closing costs when you refinance. Still, Morgan says, homeowners who are planning to live in the house for many years may want to refinance if rates drop by as little as one-half a percentage point, because this reduces the payment, especially on a large loan balance, and the interest savings over time can be significant.
Are you consistently losing to cash offers? Is there a house you just can't live without? Do you want to purchase before you sell? We have a lender who will purchase the home for you as cash and put you in the driver's seat. You will then refinance into the loan after closing which allows you to compete at a different level!
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