An improving housing market is great for the economy but not necessarily for first-time homebuyers. According to HSH.com, mortgage rates rose from 4.4 percent in April up to 4.90 percent in October.
While rising mortgage rates certainly make transactions more expensive, they shouldn’t deter your purchase. Here are eight ways you offset the effects of higher mortgage rates when buying a home:
No. 1: Make a bigger down payment
A larger down payment can ease the pain of housing payments, says Jim McQuaig, branch manager of Churchill Mortgage in Herndon, Va. “Not only are you financing a lower balance, but if you make a down payment of 20 percent, you eliminate private mortgage insurance (PMI).”
For example, a 30-year, $250,000 loan at 4.5 percent with a 20 percent down payment ($50,000) has a monthly payment of $1,353, says McQuaig. That same purchase with a down payment of 5 percent ($12,500) will cost $1,666 per month, including PMI.
No. 2: Pay points
“You can lower your mortgage rate and your payments by paying one or two discount points,” says Clint Madison, senior mortgage banker with Envoy Mortgage in Walnut Creek, Calif. One discount point brings down your rate by about 0.25 percent, he says.
For example, on a $350,000 purchase with a down payment of 5 percent ($17,500), paying one point ($3,325) would lower the rate from 4.875 to 4.625 percent and reduce the monthly payment from $1,760 to $1,710, says Madison. Applying the extra $3,325 to the down payment instead would create a payment of $1,741.
No. 3: Equity sharing
Equity-share arrangements can be made with parents, investors or friends, says McQuaig.
“You can negotiate an equity share deal in which the parents put in the cash for the down payment that’s repaid when the home sells along with a share in the profit,” he says. “For instance, if the investors make a 20 percent down payment on a $200,000 home, they’ll get $40,000 back along with 20 percent of the equity in the home.”
No. 4: Switch loan products
Many buyers opt for an FHA mortgage because of the 3.5 percent down payment requirement, but FHA mortgage insurance is higher than PMI, says Madison. If you come up with another 1.5 percent for a 5 percent down conventional loan, your monthly payments will be much lower, he says.
“A $350,000 purchase with an FHA loan at an interest rate of 4.75 percent will cost $2,044 per month including principal, interest, taxes, insurance and mortgage insurance,” says Madison. “With a 5 percent down payment and a conventional loan interest rate of 4.9 percent, the monthly payment including PMI will be $1,992.”
No. 5: Shorter terms
Interest rates on 15-year mortgages are lower than 30-year mortgages, but few first-time buyers can afford the higher payments, says McQuaig.
“A better choice, particularly for buyers who don’t intend to stay in their home for long, would be a 5/1, 7/1 or 10/1 ARM, which have a lower interest rate than a fixed-rate loan,” says McQuaig.
For example, the payment on a $250,000, 30-year loan at 5 percent would be $1,342 and $1,194 on a 5/1ARM at 4 percent, he says.
No. 6: Downsize expectations
If you can’t afford to buy what you want, look for a home in a different neighborhood or downsize to a less expensive home, says Angie Delboy, a Realtor with Re/Max Gateway in Lorton, Va.
“Another option is to look at places that need a little work. You need to make sure the price makes sense with the condition,” she says. “A home that has a newer roof and windows but needs a fresh coat of paint can be a good buy.”
No. 7: Buy with friends or relatives
“If you buy with friends or relatives, you need to have an exit strategy or you open yourself up to problems,” says Delboy.
Madison says both owners need to qualify for the loan, although only one needs to make a down payment.
“If you buy with friends you should look at it as going into business with them,” says McQuaig. “Every aspect of this arrangement should be in writing to avoid future conflicts.”
No. 8: Bring in a renter
Lastly, you might consider bringing in a renter. Delboy says you must be able to afford the payments in case your renter moves out.
“You can’t use potential rent to qualify for the loan, but you can use the rental income to make your payments more affordable,” says McQuaig.