Homebuyers are falling off and looking to other options because mortgage rates are simply too high.
But what is a mortgage and why are rates higher now than in 2008?
What is a mortgage?
By this point, most Americans have heard that we are in a housing slump. One factor contributing to this slowdown is increased mortgage rates. But, what is a mortgage? A mortgage is a type of loan used to purchase or maintain a home. It is an agreement where the borrower agrees to pay the lender in a series of payments over time. Payments are divided into principal and interest. The property then serves as collateral to secure the loan.
A borrower must apply for a mortgage. However, there are several requirements including minimum credit scores and down payments. There are a few different types and they vary based on the needs of the borrower.
Individuals and businesses use mortgages to buy real estate without paying the entire purchase price up front. The borrower repays the loan with interest for a certain number of years until they own the property. Typical mortgage terms are for 30 or 15 years.
Mortgages are also known as liens against property or claims on property. If the borrower stops paying, the lender can foreclose the property.
Mortgage rates over 6%
Mortgage rates are on the rise. Now, we have passed the 6% mark– the highest level since 2008. In the week ending September 15, the 30-year fixed-rate mortgage averaged 6.02%. The week before that, the rate was 5.89%. At this time last year, the rate was 2.86%. High inflation continues to push rates up.
The Federal Reserve does not set the interest rates borrowers pay on mortgages directly. However, their actions do influence the borrowers. Because rates are still rising and home prices are high, house sales are slowing.
Applications for home loans have dropped. Applications to refinance into a lower payment have fallen dramatically– down 83%.
Freddie Mac did some calculations based on a $390,000 home financed with a 30-year, fixed-rate mortgage after a 20% down payment. Last year, the average interest rate was 2.86%. This would mean a monthly payment of $1,292. In comparison to this year– with an average rate of 6.02% would be $1,875. That is $583 more each month. This is so problematic because median household incomes are remaining relatively unchanged.
How should I prepare to get mortgage?
A home is often the biggest purchase someone will make. That means that it is important to prepare for the mortgage application process to ensure you get the best rate and monthly payments within your budget. Quick tips to prepare you for a mortgage:
- build your credit
- make a budget
- start a savings for a down payment and expected monthly payments
- do research to see what mortgage type is best for you
- compare rates
- select the right lender for you
What determines my rate?
Shopping around for rates and getting quotes from multiple lenders is one of the most important pieces. Keep in mind that there is more to think about than just the interest rate. Be sure to compare APRs, which include many additional costs of the mortgage not shown in the interest rate. Some institutions have lower closing costs than others too. Some of the biggest factors in determining mortgage rates are:
- credit score
- down payment
- property location
- loan amount/ closing costs
- loan type
- loan term
- type of interest rate
What are the different mortgage types?
Fixed rate mortgages are standard. With this type, the interest rate stays the same for the entire term of the loan along with the monthly payments. This is also called a traditional mortgage.
Adjustable-rate mortgage (ARM)
With an adjustable-rate mortgage (ARM), the interest rate is fixed for an initial term, then will change periodically based on interest rates. Typically, the initial interest rate is below-market rate, which can make the payments more affordable in the short term but possibly less affordable long-term if the rate rises substantially. ARMs typically have limits on how much the interest rate can rise each time it adjusts and in total over the life of the loan.
This mortgage type can involve complex repayment schedules and are best used by sophisticated borrowers. Lots of homeowners got into financial trouble with these types of mortgages during the housing bubble of the early 2000s.
Reverse mortgages are designed for homeowners age 62 or older who want to convert part of the equity in their homes into cash. These homeowners can borrow against the value of their home and receive the money as a lump sum, fixed monthly payment, or line of credit.