Managing the impact of rising rates on buyers

by Jason Porterfield

A robust seller’s market has dominated the real estate industry in recent years. Low interest rates compelled many people to buy, while scarce inventory helped push prices up in markets across the country.

Those historically low interest rates have been on the rise for more than a year, while inventory is beginning to loosen up. The pendulum has begun to swing away from these ideal conditions for sellers, but it hasn’t swung all the way. In fact, in its predictions for 2019, realtor.com indicates that rising rates and slow inventory increases could make it difficult for people to purchase homes for the next few years.

“Inventory will continue to increase next year, but unless there is a major shift in the economic trajectory, we don’t expect a buyer’s market on the horizon within the next five years,” Danielle Hale, chief economist for realtor.com, says in a press release.

First-time homebuyers and older millennial buyers who made purchases when mortgage rates were in the range of 3 percent to 4 percent may be daunted by the prospect of buying a home with the cost of borrowing expected to increase. Move-up buyers may be reluctant to trade their low rates for a higher rate. Current homeowners who have low rates locked in on their 30-year or 15-year mortgage would have to borrow at a significantly higher rate. And with a slower rate of growth in home prices, there is the fear among homeowners that they may not see the return on their home that they’d hoped for.

That means the role of the agent as trusted advisor is more important than ever. “The best guidance we can provide to real estate professionals is to be sure to have a clear understanding of their customers’ home goals and objectives when helping them to select the right mortgage solution. It’s important the new mortgage product and payment fit comfortably into a customer’s overall financial plan,” says Brian Dixon, a branch sales manager at Wells Fargo Private Mortgage Banking. “When making these decisions, customers should look at factors like how long they’re planning on being in the home and the amount of risk that they’re willing to assume.”

The reality of rate increases  

In December, the Federal Reserve raised its benchmark interest rate from 2.25 percent to 2.5 percent. But instead of rising in response, mortgage rates actually fell in the final weeks of 2018 and have remained lower in the first days of 2019. Rates on 30-year fixed-rate mortgages averaged 4.45 percent the week of Jan. 10, according to Freddie Mac, while 15-year fixed-rate mortgages averaged 3.89 percent. That’s down from 2018’s high — occurring in the week ending Nov. 15 — of 4.94 percent for 30-year fixed-rate mortgages and 4.36 percent for the same version in a 15-year span. Rates have fallen nearly every week since that peak.

Leslie Struthers, vice president of mortgage lending at Guaranteed Rate, says mortgage rates had actually spiked weeks ago in anticipation of an increase in borrowing costs, and that the subsequent drop was due in part to the Federal Reserve reducing its number of expected rate increases in 2019 from four to two.
Struthers says it’s important to maintain a long-term perspective. “We are in a market of historically low interest rates,” she says. “They’ve gone from 3 percent to 4 percent to somewhere between 4 and 5 percent. There may be a change in payments by $50, $100 or $150 if you have a big loan, but historically rates are very, very low.”

But considering that rates on 30-year fixed-rate mortgages have not been above 5 percent since February 2011, it can be tough to keep buyers focused. Rates are up more than half a percentage point from where they were at the same time last year. That difference adds up, particularly for homeowners who purchased property when rates were even lower.

Steve Dykeman, vice president of mortgage lending at Blueleaf Lending, agrees that rates continue to be favorable for buyers, particularly when compared with rates he saw in 2007 that went as high as 6.75 percent. He encourages agents to help their clients see how other costs associated with buying, such as taxes, may have shifted in their favor.

“Every eighth of a percent [increase] on a small loan amounts to about $18 [on a monthly mortgage payment]. Even if it goes up by, say, a quarter percent by the time they lock in, that’s $36,” Dykeman says. “Maybe they gain that back because maybe the taxes are a little lower than we anticipated or maybe association dues are lower than anticipated. So really, the big variables in the process aren’t even the rates so much.”

Alternative strategies

Prospective homebuyers may not be convinced that taking out a traditional mortgage is the best option for them. In this case an agent may be able to connect them with the resources needed to choose an appropriate alternative to a fixed-rate mortgage that locks them into a low rate for years.

Dykeman suggests some homebuyers may have success with choosing an adjustable-rate mortgage. Rates on ARMs may vary based on how the prevailing markets are performing but they can be attractive to some homebuyers, particularly those who do not plan to keep the property for more than a few years.

“There are some really solid ARM products out there, and they’re not subprime ARMs,” Dykeman says, specifically noting loans based on the London Interbank Offered Rate, or LIBOR, index and 10- or 15-year ARMs. He says many of these products offer rates at 4 percent and are fixed for 10 years. “It’s a long-term play of security, and most buyers don’t own a home past 10 years. There are plenty of other viable options that are very good products if you’re rate-driven and looking to reduce your payment somewhat.”

Other options may include choosing an assumable rate mortgage, which are available on Federal Housing Administration and Veterans’ Administration loans. Assumable rate mortgages that give homebuyers the ability to take over payments on an existing mortgage as though they had taken it out themselves, with the original interest rate locked in for the length of that original mortgage. However, once that term is up, the homebuyer does not get to keep that rate. Buyers also have to assume the cost of the home beyond that mortgage, but at current market rates. The trade-off can be worthwhile to buyers who can lock in a few years of paying a rate in the neighborhood of 3.5 percent, but Struthers notes that this option isn’t available on many traditional loans.

“In general, you will not find them on the 30-year fixed-rate. You’re going to find them on a seven-year ARM or a 10-year ARM,” Struthers says. “Typically if I get a seven-year ARM and my mortgage is assumable, and it’s $200,000 and my rate is 3.5 percent and I have two years left on my ARM, you get two years at 3.5 percent on that $200,000.”

An assumable mortgage is just one way to lock in rates before they increase further. Dixon says that buyers who are purchasing new-construction properties that might not be delivered for nine to 24 months are often anxious about making such a long-range investment, but there are ways to take advantage of current rates.

“In these situations, real estate professionals can encourage their customers to have a conversation with a lender who can provide extended rate-lock options. Locking in today’s rate for 12 months, 18 months or 24 months — depending on the delivery date — is a great way to minimize the risk,” Dixon says. “An extended rate-lock program is an effective tool to help minimize the risk and provide interest rate security.”

The bigger picture

Struthers is unconvinced that higher interest rates are likely to dissuade potential homebuyers from making a purchase in an economy that’s still growing. While they might be paying a little more for a home than they would have paid a year ago, those who already own homes are still benefitting from increasing home prices. Higher wages and earnings from investments also mean homebuyers may have more money in their pockets to pay for the space they need, rather than having to settle for a smaller home at a more affordable price.

For those working with first-time homebuyers who are unsure about taking on a mortgage, Struthers recommends agents demonstrate how much they’ll pay on a mortgage versus what they’re paying in rent.
“Rents are rising faster than mortgage rates,” she says. Agents should help buyers focus on “what it’s going to cost you to actually wait until next year.”

Struthers notes that the impact of low apartment vacancies can be seen in the recent market moves across Chicagoland. “We’ve seen rents go up and up and up over the last few years and now developers are struggling to find rental buildings to buy,” she says, noting that rental demand is so high that many condo buildings throughout the city are being targeted for deconversion back to rentals.
Dykeman also favors showing renters how much they could save over time by making a property purchase. A hypothetical drawn up by Dykeman illustrates some of the the pitfalls of renting when one could become a first-time home buyer.

“Say that you’re paying $2,500 a month in rent, which is $30,000 a year, which over five years alone is $150,000,” Dykeman says. “You have absolutely nothing to show for it. What if you invest some of your funds?” That $150,000, Dykeman says, could look more like $110,000 with a loan that’s carefully tailored to a buyer’s ability to pay and to their specific goals: “You’re going to have to pay to live somewhere no matter what.”

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