Some homebuyers face mortgage “payment shock”. Here are ways to save
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Even with signs of a slowing housing market, home buyers are still feeling the sting of high prices and higher interest rates.
The average rate for a 30-year fixed rate mortgage is 6.7% Friday, up from 3.3% at the start of 2022, according to Mortgage News Daily. Along with this, house prices – the median is $435,000 – are on the rise 13.1% on average a year ago, according to Realtor.com.
“I think the big issue is payment shock,” said Stephen Rinaldi, president and founder of Rinaldi Group, a mortgage broker based near Philadelphia. “When I sit down with clients and the rate is in the 6’s, sometimes their payment is outrageous.”
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The difference in interest rates can be significant. For example: on a $300,000 mortgage at 6.5% for 30 years, the monthly payments for principal and interest only would be $1,896. This same 3% loan would result in a payment of $1,264 (a savings of $632). Other costs such as property taxes or mortgage insurance would be added to these amounts.
Still, there are ways to reduce the cost of buying a home. While there is no one-size-fits-all approach, you can evaluate the different options available to you and determine if one is right for your situation.
Here are some options.
An MRA could be a short-term answer
This rate is fixed for a fixed term – say seven years – then it adjusts up, down or stays the same, depending on the interest rate situation at the time.
While there’s a limit to how much the rate can vary, experts recommend making sure you’ll be able to afford the maximum rate if you’re faced with it later. As illustrated above, a few percentage points can make a big difference in the monthly payment.
Keep in mind, however, that at any time before the rate adjusts, you may be able to refinance your mortgage, Rinaldi said.
Or, if you plan to move before the initial rate period expires, an ARM may be a good idea. However, as life goes by and it is impossible to predict future economic conditions, it is wise to consider the possibility that you may not be able to move or sell.
Also, if the ARM rate isn’t much lower than a fixed rate, the savings may not be worth the uncertainty. Rinaldi said while some lenders don’t offer many discounted rates, he finds some that are around a percentage point or more lower.
While the typical mortgage is for 30 years, a shorter loan with a better rate can be attractive. The average rate for a 15-year loan is 6% as of Friday, according to Mortgage News Daily. Plus, you save a boatload of interest over the life of the loan and build home equity faster.
For example: a $300,000 30-year mortgage with a fixed rate of 6.5% would mean paying $382,786 in interest over the life of the loan. By comparison, a 15-year mortgage, even at the same rate, would result in paying $170,438 in interest over the life of the loan.
“It’s not just the difference in rates, but also the accumulation of equity,” said certified financial planner David Demming, president of Demming Financial Services in Aurora, Ohio.
At the same time, he said, if the higher payment cuts your budget too much, it might not be the best route.
If you are a first-time homebuyer with limited means, you may qualify for one of federal programs available that help you buy a home with a lower down payment and lower closing costs. In addition, state and local governments (city or county) often offer grants or interest-free loans to help buyers cover their down payment and closing costs.
Hire-purchase works in certain cases
Sometimes a potential buyer may not be able to qualify for a mortgage right away due to credit issues or a short work history. Or, they may need more time to save for a down payment, but want to move into a house and stay put.
In these cases, it may be wise to consider a lease or lease-purchase agreement. A common aspect of these arrangements is that a portion of the monthly rent is paid into an escrow account until the date of purchase a few years later, at which time the escrow amount is allocated to closing costs or a down payment. But if you leave or cannot meet the contractual obligation, the money is confiscated.
If you are considering going this route, it is important to do your due diligence and make sure you fully understand the terms of the contract, including what type of mortgage the property is eligible for and how the price of purchase will be fixed, Demming said.
You may be able to negotiate closing costs, such as the fees you pay for various aspects of the home buying process or using a lower cost title company. Or, the seller may be willing to pay some of your fees, depending on the competing offers presented.
You can also buy additional “points” (one point is worth 1% of the loan amount) to get a lower interest rate.
However, Rinaldi warns that since it can take years to break even when you go this route, it might not be worth it.
“You don’t want to pay extra origination fees because if you refinance, it’s wasted money,” Rinaldi said.