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Despite signs of a slowdown in the housing market, homebuyers are still feeling the sting of elevated prices and higher interest rates.
According to Mortgage News Daily, the average interest rate on a 30-year fixed-rate mortgage on Friday is 6.7%, up from 3.3% at the start of 2022. Alongside this, home prices — the median is $435,000 — are on average, according to Realtor.com 13.1% higher than a year ago.
“I think the main problem is payment shock,” said Stephen Rinaldi, president and founder of the Rinaldi Group, a mortgage brokerage company based near Philadelphia. “When I sit down with customers and the rate is 6, sometimes their payment is outrageous.”
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The difference interest rates make can be significant. To put this in perspective, on a $300,000 mortgage at 6.5% over 30 years, the monthly payments would be $1,896 just for principal and interest. The same loan at 3% would result in a payment of $1,264 (a $632 saving). Other fees such as property taxes or mortgage insurance would be added to these amounts.
However, there are ways to reduce the cost of buying a home. While there is no one-size-fits-all approach, you can evaluate various options that are available to you and consider whether any of them make sense for your situation.
Here are some options.
An ARM could be a short-term answer
An adjustable rate mortgage may be worth considering. The appeal of an ARM, as it’s called, is the lower initial rate compared to a traditional fixed-rate mortgage.
That rate is fixed for a period of time — say, seven years — and then adjusts up, down, or stays the same depending on where interest rates are at that point in time.
While there is a limit to how much the rate can change, experts recommend making sure you can afford the maximum rate if you are confronted with it later. As illustrated above, a few percentage points in the monthly payment can make a big difference.
But remember, you can always refinance your mortgage before the interest rate adjusts, Rinaldi said.
Or, if you want to relocate before the end of the original interest period, an ARM can make sense. However, as life happens and it is impossible to predict future economic conditions, it is wise to consider the possibility that you will not be able to move or sell.
Unless the ARM rate is much lower than a fixed rate, the savings may not be worth the uncertainty. Rinaldi said that while some lenders don’t offer much in terms of discounted rates, he does find some that are about a percentage point or more lower.
15-year mortgages reduce your interest payments
While the typical mortgage is for 30 years, a shorter loan with a cheaper interest rate can be attractive. According to Mortgage News Daily, the average interest rate on a 15-year loan as of Friday is 6%. Plus, you’ll save a boatload of interest over the life of the loan and build equity in the home faster.
To put this in perspective, a $300,000 30-year mortgage with a 6.5% fixed rate would mean that you would have to pay $382,786 in interest over the life of the loan. In comparison, a 15-year mortgage, even at the same interest rate, would result in paying $170,438 in interest over the life of the loan.
“It’s not just the interest rate differential, it’s building equity,” said board-certified financial planner David Demming, president of Demming Financial Services in Aurora, Ohio.
At the same time, he said if the higher payment is pushing your budget too hard, it might not be the best way to go.
Programs for first-time home buyers can help with the costs
If you are buying a home for the first time with limited funds, you may be able to qualify for one of the available federal programs that will help you buy a home with a lower down payment and lower closing costs. In addition, state and local (city or county) governments often offer grants or interest-free loans to help buyers meet their down payment and closing costs.
Rent-to-own works in some cases
Sometimes a prospective homebuyer may not immediately qualify for a mortgage due to credit issues or brief work experience. Or they may need more time to save up for a down payment but want to move into a home and stay.
In these cases, it may make sense to think about a rental or hire-purchase agreement. A common aspect of these agreements is that a portion of the monthly rent will be placed in an escrow account until the date of purchase in a few or a few years. At this point, the amount deposited goes toward closing costs or a down payment. But if you walk away or otherwise cannot meet the contractual obligation, the money is forfeited.
If you’re considering this route, it’s important to do due diligence and make sure you understand the terms of the contract — including the type of mortgage the property is eligible for and how the purchase price will be determined, Demming said.
You can also save by purchasing “points” and reducing the cost of completing one
You may be able to negotiate closing costs, e.g. B. the fees you pay for various aspects of the home buying process, or by hiring a less expensive title company. Or the seller may be willing to pay part of your cost depending on the competing offers presented.
You may also be able to buy additional “points” – a point is worth 1% of the loan amount – to get a lower interest rate.
But Rinaldi warns that it may not be worth trying to breakeven this way, as it can take years to breakeven.
“You don’t want to pay additional origination fees because if you refinance, that’s money lost,” Rinaldi said.