Home-buying season is moving into high gear, and would-be homeowners are looking for ways to finance the home of their dreams. But the mortgage market is presenting some challenging conditions right now, as investors anticipate rising interest rates that could make monthly payments more costly. By considering some key facts before you get your mortgage, you'll be in a better position to get the financing you need to buy the house you really want.
Should you lock in your mortgage rate?
Whenever mortgage rates are rising, mortgage borrowers want to know whether locking in a mortgage rate is a good idea. However, it's essential to know how your lender approaches rate locks. Typically, you can lock a mortgage rate for 30, 45, or 60 days. That's often sufficient, but if you anticipate a longer process for whatever reason, it's worth looking into trying to get a longer lock period. In some areas, that requires additional costs.
More importantly, be sure to understand what -- if any -- changes you can make to the terms of a mortgage while still preserving the rate lock. In some cases, if you change the kind of loan you want or the amount you want to pay as a down payment, it will open the door to a new mortgage rate, regardless of the lock. Similarly, if your credit score changes or if your home appraises at a different value than expected, some lenders won't be able to honor the lock. Rate locks can be useful, but you have to know the details to avoid nasty surprises.
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Can you really afford your mortgage?
In today's financial world, many lenders have to follow strict guidelines with mortgages. Typically, lenders like it when borrowers have enough gross income so that only 25% to 30% of it goes toward housing costs, including mortgage payments, real estate taxes, and homeowners' insurance. You can often find financing with higher percentages of your income going toward housing costs, but you risk overextending yourself and becoming especially vulnerable to financial problems, like losing your job.
When considering a mortgage, be sure to look at all the demands on your income. Most lenders will look at other formal debts, including auto loans and credit card balances. But if you know that you're inclined to spend certain amounts on other things, then you'll want to be careful in considering whether an outsized mortgage payment could force you to cut back on spending in areas you don't want to sacrifice. Being more conservative can limit your purchase choices, but it's often the prudent way to cut the risk of a major problem down the road.
Is an adjustable rate mortgage a smart move?
Fixed mortgages are popular among homeowners because they're predictable. Throughout the loan period, you make the same mortgage payment every month. With adjustable rate mortgages, you have to deal with the risk of interest rate resets that can result in higher monthly payments.
However, there are ways to mitigate those risks by using different types of adjustable rate mortgages. A one-year ARM gives you minimal interest rate protection, and payments can rise after just a single year. With a 5/1 ARM, however, your initial rate is locked in for the first five years, with annual adjustments after that. You can even get less frequent subsequent resets if you want. For instance, a 5/5 ARM has an initial adjustment five years in, but then the new rate is locked in for another five years.
Also, look at any limits on annual or lifetime interest rate increases. In some cases, there's a maximum interest rate applicable to the mortgage, so that no matter how far rates might rise, your mortgage will never go above that level.
The key with adjustable rate mortgages is to look beyond what you can afford now. As long as you're sure you'd still be able to afford an ARM even if rates go up, then it's worth considering whether any advantages to ARMs are worth the risk.
Be smart when you're mortgage shopping
Buying a home is exciting, but it's also a huge financial commitment. Make sure you get the best mortgage you can, and your home-buying experience will go a lot more smoothly.
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