Small interest rate changes mean big money for home buyers

April 01, 2014

Scripps News Network

As the economy continues to recover from the worst recession since the 1930s, mortgage interest rates remain at historically low levels.

The Primary Mortgage Market Survey, produced by Freddie Mac, reported in mid-March the average rate for 30-year fixed-rate mortgages was 4.32 percent; 15-year fixed-rate mortgages averaged 3.32 percent and interest rates 5-year Treasury-indexed hybrid adjustable rate mortgages averaged 3.02 percent. Nonetheless, Frank Nothaft, chief economist for Freddie Mac, speculated the Fed’s gradual tapering of its stimulus efforts may prompt a rise in mortgage interest rates.

If mortgage interest rates do rise significantly in the future, what, if any effect will there be on the home buying market? According to Steve Calk, chairman and Chief Executive Officer of The Federal Savings Bank, interest rates have never been the deciding factor for whether potential home buyers actually purchase a home.

“Whether interest rates are 5.5 percent or 7.5 percent, when people are ready to buy, they’ll buy a home,” Calk said.

Price, location, size, appreciation value – these are factors many would-be homeowners consider long before mortgage interest rates enter into the picture. However, once they begin actively searching for a home, interest rates often play a role in their ultimate buying decision.

This is especially the case when interest rates are high, according to David Reiss, Professor of Law at Brooklyn Law School.

“When people think about buying houses, they think about the price of the house. But what they really should be thinking of are the monthly costs. The average 25-year-old might not think about housing rates until they go to a mortgage broker.

“Then they discover that 8 percent interest may mean that instead of a $200,000 home they can only afford a $160,000 home,” Reiss said.

Lower interest rates also translate into more rapid amortization of mortgage loans, said Jeff Engelstad, PhD, Clinical Professor at the Burns School of Real Estate and Construction Management of the College of Business at the University of Denver.

“For example, a $100,000 loan at 4 percent (interest) will have a balance of less than $79,000 in ten years while the same $100,000 borrowed at 7.5 percent (interest) will have a balance at the end of 10 years of nearly $87,000. And, by the way, the payment on the 7.5 percent loan is nearly $223 greater than the 4 percent loan,” Engelstad said.

However, a long run of low mortgage interest rates has failed to spark the sort of boom occurred at the height of the housing bubble. Nonetheless, fluctuations in interest rates may have an indirect, yet potent effect on the overall perception of affordability among potential home buyers.

“Most consumers don’t really do the math; they only know that lower is better when it comes to interest rates. Therefore, when rates tick up, consumers often perceive the result to be worse than the reality,” he said.

Tight credit and persistent high unemployment have almost certainly played a role in depressing home buying figures during the recovery, as has the large numbers of home owners who perhaps bought homes at the height of the bubble who now find themselves underwater on their mortgages. However, many underwater homeowners could be missing out on a unique opportunity presented by the present financial climate. In a housing market where prices are depressed and borrowing is cheap, home buyers with solid incomes and good credit can find lenders willing to extend credit on favorable terms, ultimately putting them ahead financially, even if they sell their present homes at a loss, according to Reiss.

“Many people feel stuck in place because they are underwater or the market is bad. But although it may be counterintuitive, it could actually be a smart move to sell in a bad market. It’s a bit more sophisticated strategy, but you could move out of a cheap home into a better home for not that much money,” Reiss said.

Calk insisted that the perception that only buyers with perfect credit could qualify for mortgages was a myth, stating that his institution had extended credit to home buyers with credit scores as low as the mid 600s throughout the financial crisis. Many buyers obtained loans with down payments as low as 3.5 percent for loans backed by the FHA; veterans often qualified for mortgages with no money down.

Calk conceded that nearly all these loans required either Mortgage Insurance Premium for FHA-backed loans or Private Mortgage Insurance for conventional loans. Nonetheless, when compared with historically typical interest rates of 8 percent, present low mortgage interest rates represent a golden opportunity for would-be home buyers to enter the market, according to Calk.

“Right now, rates are insanely low, the lowest of my entire life. People said in the 1990s when interest rates were at 6 percent that rates hadn’t been so low since their grandparents’ time,” Calk said.

For buyers with good or excellent credit, rate locks can guarantee a favorable interest rate for a set period of time. However, rate locks can create higher closing costs, especially when the rate locks are set for longer periods of time. Rate locks for new construction are potentially especially costly, according to Malcolm Hollensteiner, Director of Retail Lending Sales and Production at TD Bank.

“During this process, the lender has an obligation to deliver that interest rate within the specified period of time. While a 60-day rate lock is most common, some borrowers ‘lock in’ for a mortgage longer than this period, resulting in a higher cost at closing time or a higher interest rate to be paid during the length of the loan to reduce the cost at closing time. For example, a new home being constructed for 180 days or more can make the cost of the lock-in rate more expensive,” Hollensteiner stated.

Education and due diligence in maintaining good credit are the most potent tools that potential home buyers can employ, whether they are seeking their first home, a larger home or are scaling down to smaller quarters as empty nesters. Obtaining prequalification can provide home seekers with a better idea of precisely how much house they can afford, Reiss said.

Calk recommends that buyers go a step further and obtain preapproval along with a guaranteed rate lock from a lender. Doing so can also remove some of the intimidation factor from the home buying process.

“Buying a home should not be a frightening process,” Calk said.