Six tips for home buyers facing soaring rates
Sharply higher mortgage rates and rising home prices have made home buying less affordable this fall. Steven Senne
If you’ve been house-hunting in recent years, you’ve really been through it. Maybe you were waiting out the market, hoping the rocketing prices would start to flatten. Now, of course, they have — but from 2021 to 2022, mortgage rates have more than doubled, from less than 3% to nearly 7%.
The math on a 30-year, fixed-rate loan for a $600,000 house with a 10% down payment tells the tale: At a 4% interest rate, the monthly payment would be $2,500. At 7%, the payment is $1,100 higher, at $3,600.
“Every buyer needs to do a gut check” on how much house they can afford now, advises Patrick Holland, vice president at Embrace Home Loans in Fairfax, Va.
Here’s what you should ask yourself: Do higher interest rates make it harder to qualify for a home loan? In short, yes. Because higher interest rates mean your monthly mortgage payment will also be higher, the income required to qualify for a home loan goes up, too.
When rates were 2.9%, for example, the average borrower needed an income of $133,450 to buy a $750,000 home with a 20% down payment, said Hope Morgan, branch manager at Mortgage Network in Salisbury, Md. At a rate of 6.9%, that same loan would require an income of $195,700; the monthly payment would increase from$3,114 to $4,567.
Should my housing payment max out at 28% to 30% of pretax income? Financial experts frequently recommend keeping your housing payment within this range. But this is only a generalization. Depending on your personal circumstances, which may include college or private school expenses, you may need to budget much less of your monthly income for housing to keep your finances under control.
How can I get a lower interest rate? If you have extra cash, you can ask your lender to show you the difference in your monthly payment if you make a bigger down payment or pay extra to “buy down” the mortgage rate. Typically, “buying down” the rate involves paying a percentage of the mortgage balance (called a point) at closing to lower the mortgage rate for the life of the loan. One point is equal to 1% of the loan amount. The amount the rate will be lowered depends on the lender’s offer. Some lenders also offer to lower the rate for the first year or two for a smaller fee.
Before you go this route, though, it’s important to consider how long you’ll stay in the house, which helps you determine the break-even point when you’ll recoup the extra cash you’ll have to spend to get the savings on your monthly payment, said Isabel Barrow, director of financial planning for Edelman Financial Engines in Alexandria, Va. “It may not be worth it if you’re in the housefor just a few years.”
Adjustable-rate mortgages (ARMs) also tend to become a popular option when rates rise because they offer a lower initial interest rate, but they carry significant risk.
ARMs typically have caps on how much rates can increase each year and over the life of the loan; those limits are often 2% annually and a maximum of 5%. So this loan could go as high as 10%. A homeowner who isn’t prepared for the adjustment might not be able to keep up with the payments and lose the home. Many financial experts, including Barrow, caution against ARMs.
What are the penalties if I use money from my retirement account to buy a house? It might be tempting to see the cash sitting in your 401(k) and decide to take an early withdrawal or borrow against it for your down payment.
But this should be a last resort, says Momodou Bojang, a financial adviser and CEO of Axiom Value in Rockville, Md.: “You can borrow to buy a house, but you can’t borrow to fund your retirement.”
Plus, “if you withdraw the money from your 401(k) rather than take a loan, you’ll pay a 10% penalty and income taxes on it at your regular income tax rate,” Barrow said. “This is a lose-lose situation because if you’re borrowing because your home is hard to afford, you’re also going to have to work harder to save more to rebuild your retirement savings.”
Barrow says taking out a loan against your 401(k) is marginally better because there’s no immediate penalty or tax consequences, but you’ll lose the long-term benefit of letting that money earn value while sitting untouched. In addition, if you don’t repay the loan quickly enough, or you lose or leave your job before it’s paid in full, you’ll be required to pay taxes and a penalty on the loan balance.
Should I cash in stocks to afford a house? Financial experts say tappingnonretirement investment accounts to increase your down payment is preferable. But there are tax implications.
“If you’ve owned the stocks for a long time and have a capital gain, you’ll pay a capital-gains tax” on the profit you’ve made on those stocks since first buying them, Bojang said. But, he added, the capital-gains tax will still likely be lower than the income tax you’d pay on a withdrawal from a retirement account.
Still, no one is advising that you drain your savings and investments to get into a house. Indeed, once you become a homeowner, having cash on hand will be more important than ever. “Big expenses can crop up unexpectedly,” Barrow said. “We recommend keeping six months to two years of living expenses accessible.”
Can I refinance later when interest rates come down? Some buyers assume that if they lock in today at a 7% interest rate, they’ll be able to refinance when mortgage rates eventually decline — but there’s no guarantee that mortgage rates will come down, or that home values will keep rising.
“If your mortgage payment is too high for comfort and inflation continues, you could end up having to sell your home ... into a worse housing market” or wind up unable to refinance into a lower rate, Barrow said.
Refinancing also comes with upfront costs. Generally, you’ll have to come up to 1.5% of the new loan amount in closing costs.
The math on a 30-year, fixed-rate loan for a $600,000 house with a 10% down payment tells the tale: At a 4% interest rate, the monthly payment would be $2,500. At 7%, the payment is $1,100 higher, at $3,600.
“Every buyer needs to do a gut check” on how much house they can afford now, advises Patrick Holland, vice president at Embrace Home Loans in Fairfax, Va.
Here’s what you should ask yourself: Do higher interest rates make it harder to qualify for a home loan? In short, yes. Because higher interest rates mean your monthly mortgage payment will also be higher, the income required to qualify for a home loan goes up, too.
When rates were 2.9%, for example, the average borrower needed an income of $133,450 to buy a $750,000 home with a 20% down payment, said Hope Morgan, branch manager at Mortgage Network in Salisbury, Md. At a rate of 6.9%, that same loan would require an income of $195,700; the monthly payment would increase from$3,114 to $4,567.
Should my housing payment max out at 28% to 30% of pretax income? Financial experts frequently recommend keeping your housing payment within this range. But this is only a generalization. Depending on your personal circumstances, which may include college or private school expenses, you may need to budget much less of your monthly income for housing to keep your finances under control.
How can I get a lower interest rate? If you have extra cash, you can ask your lender to show you the difference in your monthly payment if you make a bigger down payment or pay extra to “buy down” the mortgage rate. Typically, “buying down” the rate involves paying a percentage of the mortgage balance (called a point) at closing to lower the mortgage rate for the life of the loan. One point is equal to 1% of the loan amount. The amount the rate will be lowered depends on the lender’s offer. Some lenders also offer to lower the rate for the first year or two for a smaller fee.
Before you go this route, though, it’s important to consider how long you’ll stay in the house, which helps you determine the break-even point when you’ll recoup the extra cash you’ll have to spend to get the savings on your monthly payment, said Isabel Barrow, director of financial planning for Edelman Financial Engines in Alexandria, Va. “It may not be worth it if you’re in the housefor just a few years.”
Adjustable-rate mortgages (ARMs) also tend to become a popular option when rates rise because they offer a lower initial interest rate, but they carry significant risk.
ARMs typically have caps on how much rates can increase each year and over the life of the loan; those limits are often 2% annually and a maximum of 5%. So this loan could go as high as 10%. A homeowner who isn’t prepared for the adjustment might not be able to keep up with the payments and lose the home. Many financial experts, including Barrow, caution against ARMs.
What are the penalties if I use money from my retirement account to buy a house? It might be tempting to see the cash sitting in your 401(k) and decide to take an early withdrawal or borrow against it for your down payment.
But this should be a last resort, says Momodou Bojang, a financial adviser and CEO of Axiom Value in Rockville, Md.: “You can borrow to buy a house, but you can’t borrow to fund your retirement.”
Plus, “if you withdraw the money from your 401(k) rather than take a loan, you’ll pay a 10% penalty and income taxes on it at your regular income tax rate,” Barrow said. “This is a lose-lose situation because if you’re borrowing because your home is hard to afford, you’re also going to have to work harder to save more to rebuild your retirement savings.”
Barrow says taking out a loan against your 401(k) is marginally better because there’s no immediate penalty or tax consequences, but you’ll lose the long-term benefit of letting that money earn value while sitting untouched. In addition, if you don’t repay the loan quickly enough, or you lose or leave your job before it’s paid in full, you’ll be required to pay taxes and a penalty on the loan balance.
Should I cash in stocks to afford a house? Financial experts say tappingnonretirement investment accounts to increase your down payment is preferable. But there are tax implications.
“If you’ve owned the stocks for a long time and have a capital gain, you’ll pay a capital-gains tax” on the profit you’ve made on those stocks since first buying them, Bojang said. But, he added, the capital-gains tax will still likely be lower than the income tax you’d pay on a withdrawal from a retirement account.
Still, no one is advising that you drain your savings and investments to get into a house. Indeed, once you become a homeowner, having cash on hand will be more important than ever. “Big expenses can crop up unexpectedly,” Barrow said. “We recommend keeping six months to two years of living expenses accessible.”
Can I refinance later when interest rates come down? Some buyers assume that if they lock in today at a 7% interest rate, they’ll be able to refinance when mortgage rates eventually decline — but there’s no guarantee that mortgage rates will come down, or that home values will keep rising.
“If your mortgage payment is too high for comfort and inflation continues, you could end up having to sell your home ... into a worse housing market” or wind up unable to refinance into a lower rate, Barrow said.
Refinancing also comes with upfront costs. Generally, you’ll have to come up to 1.5% of the new loan amount in closing costs.