Today's mortgage rates are fairly low, but not as low as rates late last year. Here the 10 smartest moves you can make in the mortgage market.
* When you start shopping, take a close look at how long you expect to have this mortgage.
"That may be different from how long you'll be in the home," said Keith Gumbinger, vice president for a financial publishing firm. Maybe you know you'll move up after you've built some equity in the house. Maybe you know you'll refinance the house in a couple of years to pull out some of the equity you've built and spend it on improvements.
* Enlarge your thinking beyond the 30-year fixed-rate mortgage.
"The 30-year fixed mortgage is the most expensive option," Gumbinger said. To cover 30 years' worth of contingencies, lenders charge the highest rate going any given day, he said. "You frequently buy 30 years' worth of stability and never use it."
For example, you realize your time frame in this house is probably not 30 years, but 10. It's cheaper to borrow money for 10 years than for 30. So you can look for a mortgage that's a better fit. "Why pay for a part of the yield curve that you're not using?" said Robert Van Order, chief economist for Freddie Mac.
* Consider a balloon mortgage. Balloon mortgages used to be scary. The advantages were a lower interest rate and a modest-sized payment, but the lump sum was due in full after three, five or seven years. You had to produce cash or refinance, and mortgages weren't always as easy to get as they are now. Now Freddie Mac has a new generation of two-step balloon mortgages. They have such names as the "5/25 balloon" or the "7/23 balloon" and can be good if you are in a short-term situation.
With these, a lower interest rate is locked in for that first five or seven years. After that, if you haven't sold the house or refinanced, you'll be switched automatically to a conventional 30-year mortgage, for the 23 or 25 years that are left. It's sort of a no-fee refinance. At that point, your interest would be pegged about half a percentage point above the going rate. You're also free to refinance in the open market.
Shop for a balloon mortgage carefully. Right now the advantage varies from negligible (one-tenth of 1 percentage point) to pretty good (three-fourths of a percentage point.)
* Consider an adjustable-rate mortgage. An ARM, as these loans are called, starts with a low interest rate but adjusts every year, keyed to the bond market. This type of mortgage moves most risk away from the lender and over to you, so you pay lower interest. The allowable change each year is capped, often at 2 percent with total change limited to 6 percent.
Fannie Mae, which backs many mortgages, has a hybrid ARM that gives the borrower more security, notes Fannie Mae chief economist David Berson. It locks in your lower initial rate for three, five, seven or 10 years. After that it adjusts every year. These would be called a "3/1 ARM" or a "7/1 ARM." The longer the locked-in time, the closer the interest rate is to a 30-year mortgage.
An ARM can be good if you know you won't stay in either this house or this mortgage for a long time. The short-term ARMs, especially, may have good rates for the first fixed period. A one-year ARM, for example, might have interest that is 1.5 percentage points to 2 percentage points lower than the going rate, although it would go up the following year. A five-year ARM right now might save half a percentage point to 1 percentage point at first.
Shop carefully; rates vary a lot. Remember they will go up eventually to something a little higher than the going interest rate. During the early years of an ARM, you have the options of locking your mortgage into a fixed rate. If you do, it will be a fraction of a point above the current rate at that time.
* If you already have an ARM still at its low rate, don't let this recent rate rise panic you into locking in today's higher rate.
No one truly knows what interest rates will do next. But few experts see any reason to believe rates will go up a lot more. So if you have a temporary low rate, you might as well stay with it for now. If you were quick enough to catch that brief low 6.75 percent rate last October, congratulations. That was smart.
* If you have a good mortgage rate now, but you need cash out of your house, don't refinance into an all-new mortgage. Instead add a second mortgage or equity loan.
The interest on this should be tax-deductible, just as it is on your first mortgage. But shop for a good rate. Second mortgages are not part of the national market; they're held by each local lender, so they vary widely--possibly from 8 percent to 13 percent, not counting the big fees you can pay if you have damaged credit.
Don't get a second mortgage lightly. It's a good way to eat up a substantial amount of your net worth--your home equity. Especially tempting can be a line of revolving credit charged against your home equity, in which the bank basically says: "Here's $30,000 in credit. Any time you need extra money, just write one of these special checks."
* Shop for your mortgage long before you need it.
One of the worst things you can do, said Gumbinger, is make an offer on a house and then start looking for a mortgage.
"Now you have 10 days to get financing and you don't know anything about a mortgage," he said. "Your real estate agent sends you to George down the hall.
"You say, 'Can you get me a mortgage?' " Gumbinger said.
"He says, 'No problem.' "
You have no way to know whether that mortgage broker has put you into the mortgage that is easiest for him, Gumbinger said, or the one that's in his own best financial interest.
* Shop for a mortgage as though you're shopping for a car.
"When you shop for a car you start out knowing whether you want a sports car or a dump truck," Gumbinger said. After that you figure out what options you want--air conditioning and a tape deck. Then you shop from dealer to dealer to get the best deal on that particular car.
With a mortgage, as with a car, don't put your decision in the lender's hands. Figure out the specific mortgage you want, then shop for the best price on it. First weigh how long you'll have this mortgage, then figure the best way to split your available cash between down payment and fees.
Then call lenders with the precise description of your mortgage. "You say something like, 'I'm looking for a 7/1 ARM, a conforming loan [for a person with good credit] with 10 percent down, no more than 2 points.' "
* Don't postpone buying a house until rates go down, unless you don't care if you buy one.
First of all, 8 percent interest is not a high mortgage rate--really.
Since 1975 mortgage rates have been higher than 8 percent 17 years and lower than 8 percent just seven years--the most recent seven. This has bred a pack of home buyers who believe mortgage rates are supposed to be at 7 percent, but history is not on their side.
Rates are highly unpredictable, but most experts believe that in the near future they will stay roughly a quarter point either way of where they are now. Opinion leans toward a slight drift down--one-eighth or one-quarter of a point. But even if that happens, it's not enough difference for you to change your plans.
* If you need a jumbo mortgage, take the above advice more seriously.
Jumbo mortgages, those over $240,000, are not funded by Fannie Mae and Freddie Mac but by private investors, so rates run a little higher. The difference between a jumbo and non-jumbo mortgage varies week to week. Right now it's at the high end of normal--jumbo mortgages being as much as half a percentage point higher than a non-jumbo. For example, they could be as high as 8.5 percent instead of 8 percent to a person who pays zero points.
Some lenders have jumbos as low as 1/8 percent higher, though, so smart shopping is important. In addition, the extra cost of a jumbo mortgage almost disappears with shorter-term ARM mortgages, so jumbo mortgage shoppers should take a good look at those too.
There's still another smart thing to do. It's for people who already have a pretty good mortgage: Sit back smugly; do nothing.
If you don't particularly need a mortgage, stop thinking about it. Don't let yourself be pressured into tinkering with your mortgage. Lenders like to give us new reasons to finance, because they make money any time we do.
Even if you need to make a move, don't overreact to a rise in rates that--after seven low-interest years--feels more significant than it really is.
"It's not clear," said Van Order, "that people should do anything they would not have done before."
Fannie Mae and Freddie Mac do not give mortgages personally to borrowers, they provide the money for mortgages you get from your local lender. To find out about mortgages discussed here, do not call Fannie Mae or Freddie Mac. Call local lending firms.
As Rates Rise, Don't Despair
So, how much house-buying power did you lose when mortgage rates went up? Most buyers will find the change is enough to notice, but not big enough to derail their plans.
Let's say this rise has been 1 percentage point--to 8 percent from 7 percent. That's average for a 30-year fixed loan, for a borrower with pretty good credit who pays no upfront points.
Yes, the rate hit 6.75 percent for one brief moment in October, but probably only three people got it, so don't make yourself miserable.
Here's what happens to your future buying power when the interest rate on a 30-year fixed loan rises to 8 percent from 7 percent.
For every $100,000 of your mortgage, the 1 percent increase raises the monthly payment by $69. For example, on a $100,000 mortgage at 7 percent, your payment for principal and interest only would be $665. At 8 percent, it's $734. (Probably your payment also includes a charge for taxes and insurance, but interest rates don't affect that.)
If you must keep the monthly payment unchanged, you'd have to get a smaller mortgage, probably by buying a less expensive house. To end up with the same mortgage payment after the interest rate goes up 1 percentage point, you'd have to cut your spending by 9 percent. So instead of a $100,000 house, you'd buy one for $91,000. Another choice would be to make a larger down payment if that's possible.
Finally, remember that in the long run, tax savings pay back part of increased interest. In the 28 percent tax bracket, that extra $69 a month falls to $50 after you file taxes.
-- Judy Rose