Are you considering the purchase of a home? While the Fed chose not to raise interest rates in September, it is likely to do so in the near future. This gives you limited time to lock in a mortgage rate before the anticipated increase.
The Federal Open Markets Committee (FOMC) which sets the Federal Reserve (Fed) monetary policy, held off again on increasing its historically low interest rate. This decision came on the heels of an unprecedented seven-year era of short term interest rates near 0%. Although the timing is uncertain, it is likely that the Fed will be increasing short term interest rates before the end of this year. This will cause a ripple effect through the markets as financial products get re-priced with higher interest rates. For aspiring homeowners, this will likely translate to higher mortgage rates.
With rates likely to go up, this might be the time to buy that home you have been scouting and lock in a cheap rate. Keep in mind that not all mortgages are equal. Here is what you need to know to ensure you get the best mortgage for your situation:
Compare Several Lenders
According to the Consumer Financial Protection Bureau, 47% of homebuyers don’t compare lenders. Additionally, 77% of borrowers only apply with a single lender or mortgage broker. This can cost you in the long run. Even a small difference in interest rates can greatly affect how much you'll end up paying. For example, an interest rate of 4.0% instead of 4.5% on a 30-year fixed rate conventional mortgage can mean as much as $60 in savings per month, $3,600 over the first five years, and $21,600 over the life of the loan. That’s money you can put back into your home by either paying down the principal faster or making improvements!
Shop around and fill out applications with several lenders to ensure you are getting the best rate. It will take some time and research on your part, but the savings could be worth it. Make sure you are comparing apples to apples by taking into account any additional mortgage related costs, such as points and loan origination fees.
Pick the Right Mortgage Product
One of the biggest mistakes home buyers make is choosing the wrong mortgage product. Why over pay for your mortgage when you don’t need to? Many buyers tend to default to the 30-year fixed-rate mortgage, which is the most expensive of all the mortgage products. The interest rate is typically the highest, because you are locking in a fixed rate for a long time, which represents a greater risk from the bank’s perspective.
The shorter the life of the loan, the lower the interest rate. However, the monthly payments will be higher. For most home buyers, their choice between a 15-year and a 30-year mortgage is usually based on whether the monthly payment will fit into their budget. If a shorter loan repayment period works, then the overall payback amount will be significantly less.
Homebuyers should also consider the time horizon for owning a home when choosing a mortgage. For example, if you plan to stay in your new home for less than five years, then a 5/1 Adjustable Rate Mortgage (ARM) may be the better and less expensive option. The 5/1 ARM is amortized over thirty years, but the interest rate resets each year at the end of the initial five-year fixed rate period. Having a loan with a variable rate is risky because the rate can go up or down at each adjustment period, changing your monthly mortgage payment. For this type of mortgage to be appropriate, you need to be certain about your time horizon. If unsure, then you may be better off being conservative and picking a mortgage product with a longer fixed interest rate period.
There are multiple mortgage products available with both fixed and variable interest rates. Using a mortgage calculator to determine the overall costs of various options that are appropriate for you is recommended.
Summary
For aspiring homeowners, the good news is rates are still stuck at historically low levels. The bad news is they are likely to go up. Given the mortgage rate ultimately determines how much you’ll end up paying for your home as well as the size of your monthly payments, it makes financial sense to shop around. By comparing several lenders and choosing the appropriate product that matches your needs, you can shave thousands of dollars off the total cost of your home.