Over the past few months mortgage rates have begun to rise a bit. And the expectation is that they may continue to drift higher throughout 2017. While there’s no question mortgages now cost more, I want anyone thinking of buying a home, or refinancing, to not over-react to higher rates. Keep in mind:
A fixed rate mortgage is still an amazing deal. Yes, yes, I know that the interest rate on a 30-year fixed rate mortgage has risen from around 3.5% last summer to 4.1% recently. That definitely makes a mortgage more expensive. But I want you to understand that 4% or so is still an amazingly good deal. Between 1971 and 2009 the average interest rate on a 30-year mortgage never dipped below 5%. And here we are still well below 4.5%.
The lowest rates go to the highest FICO credit scores. According to FICO, someone applying for a mortgage with a credit score of at least 760 might qualify for a 30-year fixed rate mortgage charging 4% interest. If the same borrower has a FICO score between 700-760 the rate rises to 4.2%. And with a score between 680-700 the rate hits 4.4%. You can’t control what happens to interest rates, but you have total control over your credit score. Make it a priority to get your score up into the 760+ level before you buy a home.
Adjustable rate mortgages (ARM) are cheaper, but riskier. With mortgage rates beginning to rise, I won’t be surprised if there is more interest in ARMs. I advise extreme caution. The way an ARM works, the initial interest rate is set for a period. With a 1-year ARM, the rate is set in stone for just 1 year. With a 5/1 ARM the initial rate doesn’t change for the first five years. If you are shopping for a mortgage right now, the interest rate on a 5/1 ARM could be around 3.3% if you have a great FICO credit score. That’s indeed a lot lower than the 4% or so you might pay for a 30-year fixed rate loan. (“Fixed” means the interest rate never changes.) I get that looks enticing. If you told me you were going to move in five or so years, I might tell you a 5/1 ARM could be smart. But if you plan on staying in a home for a long time, you must think about the “what if” scenarios after the initial period expires. If rates are higher—and remember, right now they remain very very low—you will see your rate adjusted upward. Most ARMs can increase as much as two percentage points a year, and a maximum of 6 percentage points over the life of a loan. So let’s say that in year six of your 5/1 ARM rates are much higher. You could see your mortgage rate jump from 3.3% to 5.3%. If rates kept on rising, the next year (year 7) the adjustment could send your interest rate to 7.3%. Meanwhile, if you opted for the 30-year fixed you would still be paying a mortgage with a 4% interest rate. There are plenty of online calculators that will help you game out the potential rising cost of an ARM.
Courtesy of Suze Orman
