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Mortgage interest rates can have a significant impact on your budget, especially when market rates are high. Depending on your situation, rising interest rates could make it challenging to get into the home you want or even shut you out of the housing market altogether.
In some cases, however, there are steps you can take to minimize the impact of high interest rates on your personal decision to buy a home. Here are six tips to consider.
1. Save for a Larger Down Payment
Depending on the loan program, minimum down payment requirements can be as low as 3% or even 0%. But the less money you put down, the riskier the loan is for the lender in the event that you can't make your payment. As a result, lenders typically charge higher interest rates to borrowers with lower down payments.
If you're applying for a conventional loan, a 20% down payment will help maximize your savings by helping you secure a lower interest rate and eliminating the need for private mortgage insurance (PMI). If you can't meet that threshold anytime soon, consult with a mortgage professional and come up with a down payment goal for your particular situation. You can also look into down payment assistance programs for further help.
2. Consider Government-Backed Loans
Like conventional mortgage loans, government-backed loans—including Federal Housing Administration (FHA) loans, U.S. Department of Veterans Affairs (VA) loans and U.S. Department of Agriculture (USDA) loans—are credit-based.
But on average, these government-backed home loan programs offer lower interest rates. Additionally, they may have less stringent credit approval requirements and other features that make them more attractive to low- and moderate-income borrowers.
Just keep in mind that there are also unique costs associated with FHA, VA and USDA loans, so it's still important to shop around and compare all of your options with the help of a professional to determine the best loan for you.
3. Buy Down the Rate
Mortgage discount points are a form of prepaid interest that you can use to essentially buy down your loan's interest rate.
Each discount point typically costs 1% of the loan amount and reduces your interest rate by 0.25% for the life of your loan. For example, if you have a $450,000 loan with a 6% interest rate, you'll pay $4,500 upfront to reduce the rate to 5.75%. That may not sound like much, but if you plan to live in the home for a long time, you can recoup your upfront cost.
With a 30-year fixed-rate mortgage, the 5.75% interest rate would cut your monthly payment by $71. Divide $4,500 by $71 to get a break-even point of just over 63 months in the home. If you plan to live in the house for more than five years and you don't anticipate refinancing in the future, buying down the rate could make sense.
And depending on the state of the housing market in your area, you may even be able to get the seller to pay the buy-down fee. If you don't plan to live in the home or keep the current loan for that long, however, and the seller won't agree to pay the cost, consider other options.
4. Opt for an Adjustable-Rate Mortgage
Adjustable-rate mortgages (ARMs) tend to become more popular in rising interest rate environments because of how they're structured.
Instead of giving you a fixed interest rate for the life of the loan, an ARM typically offers a fixed rate for an initial period of three to 10 years. Once that period ends, the rate becomes variable, adjusting every six to 12 months based on current market conditions and the terms of your ARM.
Because these loans carry more risk for borrowers in the long run, they often provide lower interest rates for the initial fixed period than comparable fixed-rate mortgage loans. And if you believe that interest rates will go down enough before the fixed period expires, you can refinance the loan at a lower rate later on.
Before you go this route, though, keep in mind that there's no guarantee that interest rates will decrease before your fixed period ends, potentially leaving you with a more expensive loan in the long run. Additionally, refinancing means you will incur closing costs, which can be pricey. Depending on how interest rates change, you'll want to do the math to determine your break-even point to ensure it's worth it.
5. Improve Your Credit
While you can't control the economy, you can take steps to improve your credentials as an applicant. You can technically get approved for a conventional loan with a credit score of 620 or above, and some government-backed loan programs go even lower. But if you want to qualify for a low interest rate, your best bet is to have a score in the mid- to upper-700s.
Building your credit score can take time, but even moderate changes could have a positive impact on your interest rate. Check your credit score and credit report to assess your current standing and to identify areas where you can improve.
6. Be Patient
Mortgage interest rates are constantly fluctuating, and even if they've recently made a significant shift upward, chances are that they'll come down again at some point. While it's impossible to predict when interest rates will hit another sweet spot for borrowers, it can be wise to wait until they've reached a level that allows you to buy the home you want without breaking the bank.
If you also want to work on building your down payment or improving your credit while you wait, keep an eye on the latest interest rates to gauge your readiness.
Monitor Your Credit Throughout the Mortgage Process
Whether you're preparing yourself to buy a home or you're in the thick of the homebuying process, it's important to monitor your credit regularly to ensure you're maintaining the credit score you want and to identify potential issues as they arise.
During this time, it's also important to avoid applying for other forms of credit, which can affect your credit score and your debt-to-income ratio, both of which are important factors mortgage lenders consider.
If you have questions about how to handle your credit during the mortgage process, consult with a mortgage professional.