What To Do When Mortgage Rates Are High

Compared to the interest rates over the last decade, especially the low rates that kicked off the housing boom of 2020, current interest rates may seem exorbitantly high. But the truth is that mortgage interest rates are simply nearing long-term historical averages of 8%, and are well below rate increases reached during other inflationary periods.

As you wonder whether or not to buy a home with mortgage interest rates that have doubled over the past year, you may appreciate some perspective in accepting that your projected house payment will be hundreds of dollars higher than it would have been had you purchased the same home one to three years ago before home prices hit record highs. Higher mortgage interest rates have done little to temper demand for homes.

Here’s how consumer interest rates really work. Interest rates rise or fall depending on how the government reacts to economic circumstances. In an inflationary environment, the Federal Reserve raises overnight borrowing rates to banks, which in turn pass on the larger borrowing costs to consumers. As interest rates rise, consumer spending slows down, which theoretically brings inflation back under control. When consumers aren’t spending, for whatever reason, interest rates tend to be low, which encourages them to spend more money to keep the gross domestic product in positive territory.

A healthy rate of inflation is about 2%, explains TheBalanceMoney.com. By October 2022, year-over-year inflation was at 7.7%, and between September and October, inflation slowed to just 0.4%. According to Bankrate.com, the Federal Reserve raised interest rates by 75 basis points in November for the fourth time in 2022 with the target range of approximately 3.75% for all other interest rates in the economy. This is the highest Federal funds rate in more than a decade as the Fed aggressively tries to dampen inflation. That said, the long-term benchmark historical average Federal funds rate is 4.61%.

In a deflationary environment, falling prices are a boon to consumers, but they also suggest that a recession might be pending. During a recession, businesses lower prices to attract consumers and lay off employees to reduce expenses. The Fed then lowers the overnight borrowing rate to banks to help stimulate banks to lend money and consumers to spend money.

Mortgage rates depend on current market conditions. Just as suddenly as they’d risen, mortgage interest rates retreated toward the end of 2022.  As of November 17, 2022, fixed-rate interest rates dropped precipitously – from 7.08 percent (a 20-year high) to 6.61%, according to averages calculated by Freddie Mac, causing a flurry of mortgage loan applications.

CNN.com reported that a buyer purchasing a median-priced home costing $425,000 with 20% down at 7.08% interest would pay $2,280 monthly, while at a rate of 6.61%, the same loan payment is $2,174, saving the borrower $100 a month and $48,000 in interest over the life of a 30-year loan. In response to interest rates more than doubling in a year and more buyers sitting on the sidelines, many home sellers (20%) have reduced prices on their homes.

Despite the volatility of the mortgage market, home prices have continued double-digit increases for 46 straight weeks, found Realtor.com. But that may not continue as research firm Capital Economics predicts that home prices will fall 8% in 2023 and that price growth will recover to 2.5% by the end of 2024.

Among the reasons that homes are not likely to get less expensive is that many sellers have ultra-low mortgage interest rates, which fell to their lowest in 2016 and then again in 2020. They’re more reluctant to sell their homes and then pay so much more in price and mortgage interest for their next home. If sellers list fewer homes, lower inventory which has been a problem for three years is unlikely to slow buyer demand.

For the week ending November 12, 2022, the number of new home listings for sale fell 18% year-over-year for the 19th straight week of declines. Listing inventory, both new homes for sale and homes lingering on the market, is up 45% from a year ago, and homes that sold were on the market for eight days longer.

So, the main issues for homebuyers aren’t improving by much. Affordability is their biggest challenge, along with the uncertainty of buying with volatile interest rates, grappling with still-high inflation, and the potential for a recession where job loss becomes a possibility. Consumers are already using carrying more debt on their credit cards, which would make it even more difficult to qualify for a home loan. 

But, for those homebuyers who are waiting in the wings, it’s wise to remember that publicized mortgage rates are averages of loans that have been preapproved. You might qualify for a significantly lower rate than you may think. Attractive published rates are only available to those who are purchasing primary residences and have the best credit scores (720 or above), 20% or more of the home purchase price for a down payment, steady work history, investments, or other means of support, and want a 30-year fixed-rate mortgage loan, among other factors.

Loans for vacation or second homes command higher interest rates because the risk of default is higher than with a homestead and second homes are often rentals, which do not qualify for primary residence rates.

Because mortgage rates are volatile, it’s difficult to time the market. The stars have to align perfectly – the home, the price, and the mortgage interest rate. So you should buy when you find a home that you love that you can afford and are qualified to get a mortgage loan. Plan to stay in your home for five to 10 years and you should build enough equity to help you build wealth no matter what interest rates are doing.

While there’s a dip in rates, you can act now. Get pre-approved for a mortgage loan, but know that a lender will likely not commit to lock in an interest rate for you until they’ve evaluated the following: your down payment, closing costs, credit scores, and loan program. Your interest rate can change if you switch programs or the lender finds new information that deviates from your application.

If a home still seems out of reach, you may have to settle for something smaller, further away, and in less-than-perfect shape. In the meanwhile, concentrate on improving your finances. Start saving for a larger down payment, keep steadily employed, and don’t run up your credit cards. Meet with your lender and develop a strategy for buying a home now, or buying a home in three or six months or a year. 

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