It’s a race against time for homebuyers as mortgage rates keep rising.
The rate on the 30-year fixed rate mortgage hit 5.78% this week, up from 5.23% the previous week, marking the biggest one-week increase since 1987. Since the beginning of the year, the average rate has added more than two and a half percentage points, exacerbating an already difficult market for buyers.
“For every 1% rise in mortgage rates, your borrowing power drops about $50,000,” Scott Sheldon, branch manager at New American Funding, told Yahoo Money. “In other words, the more rates rise, the more your purchasing power diminishes.”
For any homebuyer in the market, that means you must be strategic and explore all possible ways to maintain a lid on your mortgage rate. Here’s how.
Lock your rate — but not for too long
Once you’re under contract to buy a home, lock in your mortgage rate in case rates rise more, Jeffrey Ruben, president of WSFS Mortgage, told Yahoo Money.
“If borrowers have not locked in their rate, they will need to qualify based on the more expensive monthly payment,” Ruben said, “which could result in the need to either increase the amount they put down on a home or, in the worst case, the loan application could fail.”
Rate locks generally last 30 days, but some lenders will offer up to 45 or 60 days, according to Ruben.
"We can also lock for longer periods, but there is a cost for the longer lock terms,” he said. “With the increased volatility and rising rates, longer lock periods are extremely expensive and not very practical."
Qualify for a higher rate
Hedge against increasing rates by pre-qualifying at a higher rate than the current one, according to Sheldon.
"I recommend qualifying at 6% to buy a home,” he said. “That way if rates climb to 6%, you qualify. If rates hold at today’s levels, you’d get the benefit of still being able to perform on the home purchase because you qualified at a higher rate from the start.”
If you’ve got the cash, buy a better rate. Borrowers can purchase discount percentage points upfront to secure an interest rate that supports a lower mortgage payment. And in today’s market, buying points is a must.
“Today, a 30-year fixed mortgage rate with no points is 6.75% to 6.78% with 20% down,” Sheldon said, a full percentage point higher than Freddie Mac’s average rate. “People are having shell shock because now paying points is the norm.”
There's no one formula to calculate the cost of a point. It can be 0.5% to 1% of the loan amount, for example, Sheldon said, depending on a number of factors such as market conditions, the size of your down payment, credit score, and property occupancy.
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How much a point lowers your rate also varies.
For example, in a normal market, one point would get a half-point or three-quarters of a point off your mortgage rate, according to Sheldon. “But this is not a normal market,” he said, “with a point only lowering by an eighth of a percent today.”
Your credit score also plays a role. If you have good credit, expect to pay half to one and half points to get a fair market mortgage rate, with bad credit scores paying at least two points. Those with at least a 760 credit score and 30% down payment will need to buy the fewest points.
“The majority of homeowners do not fall in this category,” Sheldon said.
Pay off debt
The debt-to-income ratio (DTI) is the percentage of your monthly income before taxes that goes toward paying your estimated mortgage payment, credit card bill, and other debt payments. It’s calculated by dividing your total monthly debt payments by your income. The higher the ratio, the higher your mortgage rate, typically.
To lower DTI, pay off any of the following before getting a mortgage:
“Paying any of these debts, ideally the ones with the lowest balances and highest [monthly] payments, is a solid rule of thumb,” Sheldon said.
Put more down
If your DTI is already low and you have extra cash on hand, add that to your down payment to help lower both your mortgage rate and monthly payments. But if your DTI is still high, you’ll get more “bang for your buck” by putting any extra cash toward your debt than your down payment, Sheldon said.
Get a cosigner
Having a cosigner on your home loan could reduce your mortgage rate if the cosigner has a good credit score and low debt. The key to a cosigner is to add to the income side of the DTI calculation without increasing the debt side too much. It’s important the cosigner understands what they’re taking on, too.
“Cosigning means they’re obligated on the loan the same way the main borrower is,” Sheldon said. “And they’re just as responsible for making the payment as the main borrower.”
Consider an ARM
Another option is an (ARM). Unlike fixed-rate mortgages that have the same interest rate over the life of the loan, the rate on ARMs can change over time. The rate resets after a set period, reflecting current interest rate conditions, which results in higher or lower monthly payments.
Right now these are attractive because the introductory rate on ARMs is lower than the rate on the 30-year fixed mortgage — the most popular option among buyers. This week, the rate on the five-year ARM was 4.33%, compared with 5.78% for the 30-year fixed mortgage.
“If the rate increase has altered a buyer's ability to borrow, an experienced lender may recommend moving them from a fixed-rate to an adjustable-rate mortgage program for the short term,” Kenyon Hunter, associate real estate broker at Evolution Ave Group RE, told Yahoo Money. “That way, if rates decrease in the future, they could refinance back into a fixed-rate mortgage.”
“Of course,” Hunter added, “looking at lower priced homes is an option as well.”
Ronda is a personal finance senior reporter for Yahoo Money and attorney with experience in law, insurance, education, and government.