With mortgage rates continuing to linger around record lows, potential homebuyers and homeowners considering refinancing should act now before they miss the boat, experts say.
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According to Freddie Mac, the average rate for 30-year fixed-rate mortgages is 3.39% as of Nov. 1. These rates will continue to stay low for the foreseeable future with the National Association of Realtors expecting the rate to hold steady around 4.1% a year from now.
Mortgage rates determine what your payments will be at any given rate—making the difference on whether you should rent or buy. Experts agree that now’s a good time to refinance or buy if you’re looking at a minimum five-year timeframe.
What determines a mortgage rate?
“Mortgage rates are set by supply and demand—how much supply there is for mortgages and how willing banks are to lend,” says Jed Kolko, Trulia’s chief economist. When the economy’s doing well, interest rates tend to be higher. “The Federal Reserve can affect rates directly by expanding the money supply or by buying mortgage-backed securities.”
The Fed sets the federal funds rate—what rate banks pay to the Fed when they borrow money—explains David Stiff, chief economist and vice president of Quantitative Research at Fiserv. At the moment, the Fed is keeping rates low until the labor market improves, which some experts expect to be when unemployment is below 6%.
“Lenders originate loans that are packaged into securities guaranteed by Freddie and Fannie and then sold throughout the world,” says Michael Fratantoni, vice president of research and economics at the Mortgage Bankers Association. A lender looks at the yields for mortgage-backed securities to set quotes to borrowers. Historically, mortgage rates are 1.5% to 2.0% higher than the 10-year Treasury as they reflect a borrower’s credit risk and that mortgages can prepay, unlike Treasuries, as well as the guarantee fee and cost of originating the loan.
“The Fed has committed to buying mortgage-backed securities until employment has improved,” says Fratantoni. Even if the Fed continues to buy these, mortgage rates will begin to drift up next year.
Mortgages rates and purchases.
What affects the affordability of purchasing a home is more a question of a three-legged stool—what’s happening to mortgage rates, home prices and household income, says Fratantoni.
“We’ve already seen home prices start to stabilize; we’ve hit bottom but the recovery is expected to be uneven,” says Stiff. He says markets that experienced the largest home price crashes, like Phoenix, Florida and parts of California, will experience double-digit appreciation because many buyers are trying to catch prices at their very bottom.
“[Mortgage rates] are a very important factor in affordability—as rates go down, your buying power goes up, everything else being constant,” says Erin Lantz, director of mortgages at Zillow. Even though rates are low, lending guidelines are very restrictive. “If you’ve bad credit or a spotty employment history, it could be hard to get a mortgage,” says Lantz.
When it comes to issuing loans, lenders want a solid credit history, a 20% down payment on average and strong employment history for the last two years, as well as a consistent and well-documented last two years of your financial history, says Lantz. “Mortgage rates are low and you can afford more but you have to be approved and lenders scrutinize borrowers much more.”
Since consumer’s buying power can’t get much better, changes in interest rates won’t have an impact, says Walter Molony, spokesperson for the National Association of Realtors. “What would be a real game changer is loosening credit standards and reverting to underwriting from a decade ago.” Since only the highest credit worthy borrowers are able to get loans today, returning to safe and sensible lending standards would cause home sales to rise 10% to 15% over current levels. For every two homes that are sold, one job in related services is created.
Refinancing Your Mortgage
Low mortgages rates are an incentive to refinance, says Lantz. “The challenge is you have to have enough equity in your home—about 20%.” If you don’t have enough equity, the Home Affordable Refinance Program (HARP) can help you benefit from low rates.
“If you’re underwater, home price increases may turn negative equity into positive equity and you’ll have a chance to refinance that you didn’t have before,” says Stiff.
To refinance, compare the rate and payment on your current loan and your potential new loan, as well as the cost of doing the refinance, says Fratantoni. “If you can save enough each month so that in six months you can pay off the cost of the refinance, it’s a good deal.”
When people refinance to a lower rate, they spend less on their mortgage and have more money left over to buy other things, which will help to stimulate the economy, says Kolko. “The lower rates make it more worthwhile for people to refinance.”
“Instead of lowering your payment, you can refinance into a shorter-term mortgage to pay it off quicker,” says Lantz. A shorter term can give you more financial flexibility in the future as you’ll pay less in mortgage interest overtime.
Depending on your old rate, you may be able to refinance into a lower interest rate and shorten the term while keeping the same or slightly higher monthly payment, says Fratantoni.
Qualifying for a Loan
“People need to look at their credit scores and how that affects their ability to buy a home,” says Molony. You can impact your credit score by paying bills on time and all or some of the principal due while not taking on any additional debt. If you’re looking to buy a new car or make another large purchase, wait until after you buy a home.
Experts also advice checking your credit report for errors and making sure your paperwork’s in order. “Low risk borrowers will get more favorable terms, like lower interest rates with less points,” says Molony.
“As the economic recovery starts to accelerate and home price appreciation picks up, banks will feel that it’s less risky to lend,” says Stiff. As credit standards loosen, consumers who can’t refinance their mortgages or purchase homes because of their credit will be able to qualify for a mortgage.
Until then, shop around—banks do compete, says Kolko. “You can get quotes from multiple lenders to see who will give you the best rate.”